Pain of higher interest rate

Suppose you took a loan of $400,000 to buy a HDB flat and pay over 25 years at 2.6% interest. Your monthly installment is $1,780. If your family income (net of CPF contribution) is $4,500, the monthly installment takes away 40% of your income. You may think that it is still manageable.

Many people are paying 40% (or more) of their family income towards the mortgage payment. They use their CPF contributions and top it with their cash contribution.

What will happen if interest rate start to rise? Thirty years ago, borrowers were paying interest at 8% on their mortgage loan.

Let us just look at the impact of interest rate at 5% per annum. Your monthly would change to $2,250. This would represents 50% of your family income.  The increase in interest rate will take away 10% of their net income. Can you afford this higher payment?

What happens when interest rate goes up to 7%? The monthly payment will jump to $$2,650. This will represent  60% of your income. The jump in interest rate from 2.6% to 7% will take away 20% of your income.

Will interest rate increase to 5%? Quite likely. Will it increase to 7%. Maybe. Some countries have interest rate at 10% or higher in recent years. Who says that this may not happen?

Lesson: avoid paying a high price for your property. make sure that the price does not exceed 5 years of your income. If your income is $4,500 a month, do not pay more than $270,000 for your property. Certainly, $400,000 is too much, and too dangerous!

Tan Kin Lian