Commentary: Consumers are feeling the effects of rising interest rates

SINGAPORE: After four interest rate hikes in 2018, the US Federal Reserve announced that interest rate hikes would be suspended due to weak inflation and slower growth in Europe and China .

This must appeal to many listeners. Interest rate increases over the past year have had consequences for investors around the world, including Singapore.

Unlike other countries where debit rates are generally dictated by the central bank, interest rates in Singapore are determined by the interbank rate offered in Singapore or SIBOR.

Fluctuations in US interest rates will affect SIBOR in Singapore, which in turn will affect local mortgage rates.

Low interest rate for almost a decade

In the past, Singaporeans enjoyed very low bank loan rates for almost 10 years – almost 1%. This is really remarkable for consumers looking for bank financing.

The low rates have allowed many to get a mortgage loan of almost 1.5%, finance a car and eventually get a small business loan at very low rates at the same time.

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However, over the past year, these rates have risen to almost 3%. Obviously, this has consequences for consumers who have already borrowed or are considering taking out new loans.

Consumers who have money do not need to borrow money. However, those who are limited in cash or who do not have enough cash are more likely to borrow from banks for larger purchases. For them, existing debt service is difficult when rates rise.

Take the example of a family whose combined net salary is about S $ 3,000 per month, which pays a mortgage loan of S $ 1,000, S $ 1,000 for the same period. child rearing, transportation and other necessities, travel.

They are pretty much recruited at the end of the month and live essentially from one paycheck to the other.

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When interest rates rise from 1.5% to 3%, the burden of servicing consumer debt has essentially doubled. Consumers, especially those in the low-income group, will have trouble paying their mortgage.

In our example, it is likely that their mortgage payment will increase from S $ 1,000 to S $ 1,500.

THREE OPTIONS

At this rate, they have three options. First, they may default on their mortgage. With such rising interest rates, some people will have trouble making ends meet.

The second option is to reduce other forms of consumption. The easiest items to reduce would be durable goods and optional items such as electronics, clothing and restaurant meals. Essentially, these marginal consumers have to tighten their belts.

The third option is to borrow on their credit cards and go into debt to support current consumption at the expense of future consumption.

Consumers who can afford higher loan payments will nevertheless be worried because many might have thought that interest rates would not rise beyond three percentage points. If it were to rise to 4%, it could also put this group on the front burner.

They need to start thinking about what needs to be done to improve their spending behavior and savings.

INTEREST RATE MOVEMENTS SHOULD NOT BE A SURPRISE FOR OWNERS

Unfortunately, interest rate fluctuations are not new. For example, in Singapore, the Housing and Development Board (HDB) offers a fixed rate mortgage option to all social housing buyers. However, these mortgages are subject to strict restrictions and their price is higher than that of bank loans.

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For example, some HDB home buyers choose to take out a bank loan for their social housing. Meanwhile, all private home buyers must obtain a bank loan.

Since banks can only lend up to 75% of the value of their home since last year, stricter restrictions have been imposed on loan-to-value limits, so homeowners will need more money for the down payment.

This will dilate their finances and force them to use their savings, savings that would have been helpful when interest rates went up.

It is also common for many buyers to buy larger homes in anticipation of their future housing needs. This adds to the current burden of debt service when rates rise.

Instead, they would have had to buy a smaller home that required a lower mortgage payment each month, which allowed them to better amortize future rate changes.

GREATER IMPLICATIONS

Rising rates will also have broader implications for the economy. Consumers and businesses are less likely to take out new loans at higher rates, which will hurt economic growth.

Therefore, banks need to think about how this transmission of SIBOR will affect their banks' lending behavior to consumers and businesses, as well as their future business plans.

Commercial banks should consider the consequences of a higher SIBOR index on their current service portfolio. First, they will have fewer homes to buy because the higher interest rate makes buying more expensive homes.

Second, many may default on their mortgages, which increases the banks' credit risk for their portfolio. We are already seeing warning signs in Singapore with the slowdown in mortgages due to rising interest rates and the latest ownership restrictions.

In addition, the impact will also extend to consumers who avoid credit cards and auto loans. Some companies will also be less likely to take out commercial loans because of high interest rates.

From a regulatory point of view, monetary policy in Singapore overseen by the Monetary Authority of Singapore (MAS) takes the form of a nominal exchange rate policy aimed at maintaining price stability. This situation, combined with the fact that Singapore has a relatively open capital account, means that MAS can not influence interest rates at the same time, without risking capital flows.

Together, this means that this rise in interest rates will inadvertently affect the most vulnerable consumers – those who do not understand the financial markets and the functioning of banks.

There are actually few effective solutions beyond financial literacy, including an understanding of what can influence loan repayment to make better decisions.

Sumit Agarwal is Professor Emeritus of Finance, Economics and Real Estate at Low Tuck Kwong at NUS Business School. The opinions expressed are those of the author and do not represent the views and opinions of NUS.