Most of us would know that interest rates have increased substantially since the start of the year. In its attempt to curb inflation, the US Federal Reserve has increased its benchmark rate to 3.75% – 4.00%, and this is expected to continue increasing in 2023.
As such, it shouldn’t come as a surprise that our local banks have recently increased their fixed home loan interest rate up to 4.5%. What this means is that home buyers, who presumably would require a loan to finance their property purchases, will now need to pay a higher monthly mortgage. For those of us who need to refinance our home loan, we should also expect to pay a higher monthly mortgage.
This brings us to a question. How much would interest rates have to rise before the monthly repayment for our mortgage doubles?
Read Also: What A 1% Increase In Interest Rates Could Mean For Your Home Loan Repayment
To answer this question. Let’s first assume that a home buyer previously enjoyed an interest rate of 1.5%. Here are some other assumptions we make.
– Interest rate: 1.5% p.a.
– Loan period: 30 years
– Loan amount: $500,000 (the amount doesn’t matter for our calculation, but we will put an amount so that it’s easier for us to relate to)
In our initial calculation, the monthly repayment is $1,726 based on a 1.5% p.a, 30-year loan. What will it take for monthly repayment to double?
Using the same calculator, we can see that we will pay a monthly instalment of $3,452 for the same loan if the interest rate increases to 7.37% p.a.
7.37% is the figure based on our example.
While this feels like a level that is quite high and won’t be touched, most of us didn’t expect rates for fixed home loans to increase from about 1+% at the start of the year, to 4+% currently either. The fact is that nobody can predict the future.
Reducing Our Mortgage Repayment Period Will Lower The Effect Interest Rate Has On Our Loan
When interest rates are low, it’s common to see loan brokers suggesting that homeowners maximise the loans they can take, and stretch it out for as long as possible. The argument here is that if borrowing is so cheap, then a homeowner is better off borrowing more over a longer period of time and to invest their excess cash elsewhere for higher returns.
We like to suggest that the opposite logic also applies. When interest rates are high, homeowners may want to consider shortening their loan period to reduce the effect that high-interest rates will have in increasing the cost of their loans.
Using the same example above, if our loan period is reduced to 10 years, monthly mortgage repayment will naturally be higher at $4,490.
In our earlier 30-year loan example, monthly repayment would have doubled if the interest rate were to increase to 7.37%.
However, for a 10-year loan, if interest rates were to increase to 7.37%, monthly mortgage repayments will be higher at $5,901. While significant, this is, at least, only 31% higher than before.
Once simply a hypothetical, the sharp increase in interest rates may require us to critically review the home property purchase we intend to make, and the loan amount and loan duration we opt for.
Given the high-interest rates for home loans offered by commercial banks, we would advise that you take an HDB loan as long as you qualify for it to enjoy lower interest rates.
However, if taking an HDB loan is not an option, then it’s vital for you to do some internal calculations and stress test various scenarios so that you know how much you can afford to pay for your monthly home loan repayment if interest rates were to continue rising in the next few years.
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