Fed interest rate hike: What this means for Singaporean homeowners

PHOTO: The Straits Times

While most of Singapore was sleeping, the US Federal Reserve raised its interest rates yet again. The latest hike is the fourth since March this year.

The latest hike sees the interest rate increase by another 0.75 points from 1.75 per cent to 2.5 per cent. The move was a bid to control inflation. Know to the common man as “The Fed”, the whispers of an interest rate hike have been swirling around the financial sector for awhile now.

The United States might be 15,549 kilometers apart from Singapore but the decisions made by the financial institutions there cause a ripple effect here given just how closely our economy is tied to that of its global counterparts. If this all sounds like Greek to you and all you really want to know is how it affects you directly, read along. Here’s the breakdown of what the FED’s interest rate hike means for you:

1. What is Fed interest rate?

The Fed essentially controls the interest rate in which institutions borrow money at, and after the massive housing and banking sector crash of 2007-2009, they lowered the cost of borrowing to near rock-bottom levels in a bid to stop the US economy from plunging into another Great Depression.

To put it simply, institutions needed money to stay afloat, and this lowered interest rate made funds a lot more accessible.

The current interest rate increase comes at a time where the Fed feels that it is an essential move to lower the inflation rate. Inflation rates are soaring around the world largely due to post-pandemic demand and the ongoing war between Ukraine and Russia. In America, inflation is increasing in a faster pace than it has in the last 40 years.

To curb inflation, the Federal Open Market Committee (FOMC) has increased the level of its benchmark fees to a range of 2.25% to 2.5%. This is expected to further increase to 3.4% in the next 6 months with subsequent hikes expected later in the year.

2. What happens when the Fed raises interest rates?

Right about now, you might be wondering why we are even talking about something that’s going on in the US. In the past, Singapore home loan interest rates were pegged to the Singapore Interbank Offer Rate (Sibor). Sibor was the cost of funds for a foreign bank to bring in money (in USD) which was usually dependent on the US interest rate.

However, Sibor is currently being phased out. The six-month Sibor was discontinued on March 31, 2022. The more commonly used one-month and three-month Sibor is due to stop after Dec  2024.

All new home loans in Singapore are now benchmarked by the Singapore Overnight Rate Average (Sora). Sora is defined as the volume-weighted average borrowing rate in Singapore’s unsecured overnight interbank cash market. In layman terms, it’s the interest rate that banks in Singapore have transacted to each other on a day to day basis. The changes to the US Fed Funds Rate have global repercussions, including an effect on the SORA.

For many Singaporeans who might have taken their home loans during the market drop in the thick of the pandemic in 2020, interest rates were at an all-time low.

Since then, things have obviously changed drastically and this has a very direct impact on the home loans that Singaporean homeowners are currently servicing. For instance, 3M SORA interest rate in January this year  was 0.194 per cent. But the 3M Sora as at July 29, 2022 is 1.2295 per cent.

Needless to say, you can expect a gradual increase in Sora over the next six months, which will in turn affect Sora-linked home loan packages.  

3. What can Singaporean homeowners do then?

If you were previously tied to a SIBOR-linked home loan package, the banks will gradually convert it into SORA ones in the coming few years. Historically, when the Fed hiked their interest rates in 2015, we saw a strong shift away from SIBOR-linked home loan packages.

As history repeats itself with interest rates set to only increase in the coming months, it only makes financial sense to steer clear of SORA-linked home loan packages. You don’t want to be at the mercy of floating interest rates given that they are only projected to rise.

It is during times like this that the security of taking up a Fixed Rate home loan package presents itself as the safer choice. This way, you won’t be disadvantaged by high floating interest rates. If you’re looking to buy a new home, it is important that you carefully consider all your options.

However, if you’re looking to get out of you SIBOR or SORA-linked home loan, you can consider refinancing into one of the two types of home loan packages that are very popular at the moment:

4. Floating vs fixed rate home loans

While fixed rate packages usually have higher interest rates than floating interest rate packages, people still gravitate towards these packages because of the complete lack of any fluctuations during the time period in which the fixed interest rate applies.

It’s important to consider your finances when refinancing into a fixed rate package earlier rather than later because of the rising interest rate environment.

For instance, if you’re taking a floating rate package with DBS to purchase a HDB:

Two-year lock-in 3M SORA (1.2295 per cent p.a. as of July 29, 2022)
Year 1 to Year 2 3M SORA + 1 per cent p.a.
Year 3 and thereafter 3M SORA + 1 per cent p.a.
Commitment period Two years
Minimum loan amount $100,000

Given the current 3M SORA interest rate of 1.2295 per cent p.a., you’ll be paying 2.2295 per cent p.a. interest for your home loan for the first two years.

Alternatively, if you were to opt for the floating rate home loan package pegged to FHR6, you’ll pay 2 per cent p.a. interest for two years:

Two-year lock-in FHR6 + 1.3 per cent
Year 1 to Year 2 FHR6 + 1.3 per cent
Year 3 and thereafter FHR6 + 1.3 per cent
Minimum loan amount $100,000

*The current FHR6 interest is at 0.75 per cent p.a.

While the SORA-linked home loan package charges less interest in the short-term, the situation might take a turn with the expected rise in the coming months. In the long term, making a fixed-rate home loan very much comparable to a SORA-linked floating rate home loan package.

A two-year fixed interest rate home loan will incur the following interest:

Two-year fixed rate 2.75 per cent
Year 1 to Year 2 2.75 per cent
Year 3 and thereafter 3M SORA + 1.5 per cent
Minimum loan amount $100,000

Given that the Fed has already made it clear that interest rates will continue to gradually increase for the next couple of months, you can’t put a price tag on peace of mind. It’s something Singaporeans are willing to pay a premium for.

5. Fixed Deposit-Linked Rate packages

Fixed Deposit-Linked rate mortgages are pegged to the Fixed Deposit (FD) interest rates of DBS, currently DBS’s Fixed Deposits Home Rate 6 (FHR6) is 0.75 per cent.

 
No Lock FHR6 + 1.75 per cent p.a.
Year 1 to Year 5 FHR6 + 1.75 per cent p.a.
Year 6 and thereafter FHR6 + 1.75 per cent p.a.
Minimum loan amount $100,000

This article was first published in MoneySmart.