13 January 2015

The Severe Threat of Rising Interest Rates for Leveraged Property Owners

Interest rates have been unusually low in recent years. From a savings account point of view, this has meant pathetic interests for savings. But on the flip side, from a loaner's point of view, it has been a wonderful thing.

Housing loans in particular have been spectacularly low, enabling many to realise the dream of owning a property. With interest rates dropping, many switched over from a fixed rate to a floating rate loan. One form of this pegs the loan to the SIBOR, especially the 3-month SIBOR or 12-month SIBOR as this provided greater transparency. For instance, 1.75% + 12-month SIBOR rate.

However, interest rates have started climbing and have started to cause a bit of concerns, particularly for those with very high leverage. They may have problem with their personal cashflow if interest rates climb. 

Compounding this is the fact that property values have also started seeing a decline. The happy years of seeing property value increase year on year is possibly past. With negative equity looming, the banks could come calling, asking for a top up to make the difference.

The Rich Dad, Poor Dad notion of positive cash flow using property leverage is going to haunt those who never considered the downside. As property value slides, their equity value may well go negative. That positive cashflow could become negative very quickly!

I am reminded of a story I learnt from the late 90's: Cashflow - A Tale of Stable Income.  When bad news come, they come together.

History can shed useful insights to enable us to make decisions today that will affect the future. But we need to learn the rights lessons given that there can be many possible futures.

As for my own housing loan, my threshold will be 4% which I view as a risk-free rate. So long as my loan interest rate remains below 4%, I will continue to maintain the loan, and use the leverage to put my spare cash and CPF-OA into investment (shares and equity Unit Trust) as I believe I can do better than the 4%. There are risks of course.

Should the interest rate climb above 4% however, I will likely liquidate my investments that are using CPF-OA funds, and use that to pay down the loan. My loan principal has actually been whittled down to just 10% of the original loan. So I really have quite a bit of breathing room. Phew.

Hope your housing finances are in good shape. If not, it's time to re-evaluate the risks and check your margin of safety. Don't let it become your nightmare and cause of sleeplessness.

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