You will be able to net out how a rate change affects you as both a borrower and a saver.
A headline says interest rates are rising. Grace's first reaction is good news: her fixed deposits will pay more. Marcus's first reaction is bad news: the home loan instalment is going up. They are both right, and they are talking about the same household. Every adult with a loan and some savings is a borrower and a saver at the same time, and a rate move pulls those two sides in opposite directions.
The useful question is which side is bigger for you. This lesson shows how to net them out, and why for most people with a home loan the answer is less comfortable than it first looks.
When rates rise, payments on floating rate debt rise at the next reset, as you saw in lesson 2.2, What SORA is and how it ends up in your mortgage. At the same time, new fixed deposits, new T-bills and eventually savings account bonuses pay more, at the different speeds described in lesson 2.3, Deposits, fixed deposits and T-bills move with rates, at different speeds.
When rates fall, both sides flip. The loan gets cheaper and the savings income shrinks.
So the first step is a simple comparison. Add up the debt whose rate can move: floating rate loans, and fixed rate loans whose fixed period ends soon. Then add up the money that earns interest at a rate that can move: savings, deposits and T-bills, but not your CPF, whose interest rates are set under CPF rules, and not investments whose returns depend on markets.
For a household with a mortgage, the debt is usually many times larger than the savings that earn interest. That decides the outcome.
Here is a worked example with made-up figures. Marcus and Grace owe S$500,000 on their flat, with 25 years left, at a floating rate of 3.0%. They hold S$30,000 in fixed deposits and savings.
Their monthly instalment at 3.0% is S$2,371.06. If their loan rate rises by one percentage point, to 4.0%, the instalment becomes S$2,639.18. That is S$268.13 more each month, or about S$3,218 a year.
Now the savings side. One percentage point more on S$30,000 is S$300 a year, or S$25 a month, and only once their deposits have rolled over into the higher rates.
So for this household, a one point rise costs about S$268 a month on the loan and brings in about S$25 on the savings. They would need more than ten times their current savings for the two sides to balance. Most mortgage holders are in a similar position, which is why a rate rise usually hurts more than it helps.
The picture is different for a household with no loan and a lot of cash, such as many retirees. For them, higher rates are mostly good news. Your own numbers decide which kind of household you are.
People are often surprised that one percentage point adds over S$250 to a monthly bill. The reason is that, early in a long loan, most of each instalment is interest.
In the first month of Marcus and Grace's loan at 3.0%, the interest alone is S$500,000 x 3.0% / 12, which is S$1,250. The rest of the S$2,371 instalment repays the loan. At 4.0%, the first month's interest is about S$1,667. The interest part has jumped by a third, and the instalment has to grow to keep the loan on track to finish in 25 years.
The bigger the balance and the longer the remaining term, the more a small rate change moves the instalment. A borrower near the end of a small loan barely notices. A couple who bought recently, at the start of a large loan, feels it most.
There is one more way rates reach you, and it applies before you borrow at all. When a bank assesses a new property loan, it does not only test whether you can afford the instalment at today's rate. MAS requires banks to work out your debt servicing using a medium-term interest rate floor, which MAS sets and can change. HDB loans follow HDB's own rules. Check the current figures on the MAS and HDB websites.
That stress test protects borrowers from taking a loan they could only just afford at today's rates. It also means that when rates rise, or when MAS raises the floor, the largest loan a bank will offer you can shrink. If you are planning to buy or refinance, a rate move can change what you can borrow as well as what you will pay.
Before you build the full stress test in the next lesson, you need the two headline numbers. For Marcus and Grace it was S$500,000 against S$30,000, and the answer was obvious. Your own figures may be closer, or may surprise you in the other direction. Find them from your latest loan statement and your bank and T-bill records, and see which side of a rate move you mostly sit on.
Write down your total floating rate debt and your total interest-earning savings and note which side is bigger.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).