Biggest interest rate hike by Fed and its implications for home loans

Image credit: http://alphastockimages.com/

The biggest interest rate hike in two decade by Fed will have an impact on all kinds of loans – from credit cards, to car loans, to home loans.

biggest interest rate hike

The Federal Reserve (Fed) moved to tamp down soaring inflation in the US on Wednesday, announcing the sharpest rise in interest rates in over 20 years. The Fed`s benchmark interest rate was raised by 0. 5 percentage points to a target rate range of between 0. 75% and 1%.

The biggest interest rate hike will get bigger

The Economist Intelligence Unit expects the Fed to raise rates seven times in 2022, reaching 2. 9% in early 2023. Rates were cut to near zero in March 2020 when the pandemic hit the US but they were already low and years of low rates left the US and other countries ill-prepared for a sudden rise in inflation. Until recently the Fed had dismissed rising prices as “transitory” and expected them to fall as economies recovered from the pandemic.

The Fed chair, Jerome Powell, took the unusual step of addressing the American people at the start of a press conference following the rate hike announcement.

“Inflation is much too high, and we understand the hardship it is causing. We are moving expeditiously to bring it back down,” he said.

“Some of us are old enough to have lived through high inflation and many aren’t. But it’s very unpleasant … If you are a normal economic person, then you probably don’t have that much extra to spend, and it’s immediately hitting your spending on groceries, on gasoline, on energy, things like that. We understand the pain involved.”

Powell said the economy remains strong and that he was confident the Fed could act without triggering a recession. He warned though that it would act aggressively to tackle inflation.

“We need to do everything we can to restore stable prices. We will do it as quickly and effectively as we can. We think we have a good chance to do it without significant increase in unemployment or sharp slowdown. But ultimately, we think about the medium and longer term, and everyone will be better off if we can get this job done – the sooner, the better.”

The Fed’s biggest interest rate hike in two decades and its impact on Singapore home loans

Mr Paul Ho chief officer at iCompareLoan said, “how the FED interest rate hike works is by making loans more expensive and technically, should lead to reduced spending.”

“The move will put pressure on Singapore’s financial institutions to raise interest rates as well,” he added.

The Fed had earlier indicated six more interest rate increases by the end of 2022. However, as inflation will eventually start slowing down later this year, mortgage rates may not rise as quickly as they have been lately.

The central bank’s forecast is for the fed-funds rate to reach 2.75% by 2023, which means it would implement 11 total hikes of a quarter of a percentage point each. The interest-rates market, to be sure, is pricing in about 10 hikes—still a lot, and still something that would drag down economic growth.

This is why you should refinance your mortgage loan now because all these raises will have an impact on your home loan.

As most home loan rates are now pegged to SORA, you will not see interest rates prematurely rising too out of step with the US Fed Funds Rate. This is because although SORA is a “backward”-looking interest rate mechanism which reacts to interest rate movements in Singapore, changes to the US Fed Funds Rate has global repercussions, so SORA is expected to react accordingly.

The biggest interest rate hike in the US will definitely dent some of the enthusiasm in the buoyant property market, and could pose a big problem for homeowners who are still servicing their mortgage loans. This is because banks and financial institutions calculate lending rates by adding a margin (which covers their costs and their profit) to a published financial index, like SORA.

If you want to refinance your mortgage loan you must be curious about how SORA, or Singapore Overnight Rate Average, works.

SORA basically uses a volume-weighted approach where the average rate of all actual transactions traded and booked in the unsecured overnight interbank SGD cash market in Singapore between 8 am and 6:15 pm. The phrase “volume-weighted” simply means that the calculations consider the actual amount being lent.

Which means that a 3M compounded SORA rate is based on a compounding period of 3 months of the historical SORA rate which is published daily on the MAS website and a 1M compounded SORA rate is based on a compounding period of 1 month of the historical SORA rate which is published daily on the MAS website.

Mr Paul Ho, chief mortgage consultant said, “All these terms, 3M, 1M, fixed rate, floating rate, etc can be confusing to some home owners who want to refinance. And also there may only be a short window of opportunity open if you want to refinance your mortgage loan.”

He added, “So, anyone who wants the best home loan should speak to mortgage consultants as they can get the best rates for home owners who want to refinance their home loans by comparing across 16 banks and financial institutions. The have the latest home loan info to guide home owners to make the right decision and best of all, their services are free.”

What are some reasons which will bring you to refinance your mortgage loan?

During a low-interest rate climate, savvy borrowers may prefer to capitalise on low interest payments by taking a market-pegged interest rate variable package. But when these borrowers are (like now) hit by the biggest interest rate hike, they may try to change the loan to a fixed rate package for some years so as to be able to lock in lower rates and better manage their cash flow.

Fixed rate packages are usually more expensive, but provide the most stability as rates are kept fixed for up to the first 3 to 5 years of the loan tenure. There is no perpetual fixed rate being offered by banks in Singapore at the current moment. This is where a refinancing guide can be useful to home owners to read-up on remortgage and be knowledgeable about the entire process.

Today, consumers have a wide range of home loan packages to choose from compared to several years ago. Home loans could also be tied up with other programmes which rewards customers with a higher interest rate on their deposits if they transact more with the bank, such as getting a home loan and crediting their salary with the same bank.

Typically, with mortgage loans you are offered attractive rates for the first three years when you refinance – following which the interest rates are adjusted upwards. This usually coincides with the end of the lock in period, offering borrowers a good opportunity to relook their loans.

But is there such a thing as a bad time to refinance your mortgage loan?

If home owners are planning to sell their home within a few months, it is usually unwise to refinance. This is because it takes some time before the savings exceed the costs of refinancing. Secondly, they may incur the penalty of the clawback period or lock-in period of the refinanced loan or legal conveyancing fees, valuation fees and other incidental fees.

Written by Ravi Chandran

higher interest rates

Refinancing versus repricing which option should I go for to get best home loan deals?

fixing

Singapore mortgage rates almost doubles in last six months, will rise further