Buying homes under inflation? What will happen next

In July, I wrote the blog post “Cash is king now”. Two months later, the trends covered in the post have advanced faster than anyone can predict. Everywhere we hear people saying, “Inflation makes everything expensive. I need more money!”

Inflation stress far more contagious than Covid-19

As of this writing, Singapore has close to 2,500 daily new cases. However, the mental stress from higher outgoing expenses and lower spending power is far more contagious than Covid-19.

Under Singapore’s highest inflation in 14 years, every day we are bombarded with talks of inflation: Journalists write about tips to save money. Colleagues complain about higher petrol prices and private hire fees. Parents grumble about rising utility bills and household expenses. Even children talk about inflation in school after they pick up the word at home.

Do we all have financial pressure from inflation? Not really. But this inflation virus is so contagious that most of us are infected by it.

A visit to the supermarket sees shoppers swiftly snap up foodstuff and groceries with discount. All things under “buy 1 get 1 free” promotion leave only the last piece on the shelf.

To illustrate with a simple example, a particular brand of instant noodles was selling at $2.2 for a pack of five for the longest time. But one fine day the price suddenly became $2.5. A week later it shot up to $2.75. By now it was selling at $2.8 in the wet market. So when there was an online promotion at $2.2, I quickly added it to the shopping cart. I was not even a fan of instant noodles. But who knows. The price may go up to $3 next year. Who can be immune to the inflation bug?

People hoarded foodstuff and groceries during the lockdown because they were afraid that these items would be out of stock. They hoard foodstuff and groceries now because they are afraid that their prices will be out of reach soon.

Untamed inflation – what will happen next

Singapore’s July core inflation excluding accommodation and private transport was 4.8 percent – the highest in 14 years. The next month in August, it hit even higher at 5.1 percent. In July, overall inflation or consumer price index was 7 percent. Last month it climbed to 7.5 percent, matching the 14-year high in June 2008. The Monetary Authority of Singapore (MAS) and Ministry of Trade and Industry expect inflationary pressures to remain high in the coming months.

In mid-August, Deputy Prime Minister Lawrence Wong said inflation in Singapore is expected to peak in the next two to four months. End of August, OCBC’s chief economist assured us that “inflation may only peak closer to October in 2022”. Maybe a safer bet would be closer to October in 2023?

After the release of disappointing figures on Singapore’s inflation rate, what will happen next?

1. Shrinking money supply

As long as inflation rate is still going up, MAS will be compelled to tighten monetary policy again. The next round will be early next month. This is already the fifth time of monetary tightening since last October. Each round results in further reduction of money supply.

Contrary to monetary easing in the last two years, there is now less cheap money available in the market. In other words, banks which used to be flooded with money now have less cash available to lend to borrowers.

2. Escalating saving rates

Consequently, banks need to come up with strategies to entice people to give them money. To attract deposit of fresh fund, banks compete with each other for savers’ money. Furthermore, they can no longer wait till the first day of every month to revise interest rates up. Instead, they have to update their fixed deposit interest rate tables anytime it fits.

For instance, after Federal Reserve raised 75-point basis point last Wednesday, Standard Chartered Bank and ICBC Bank immediately offered 2.8 percent interest for their 12-month fixed deposit. Because they know that, come October 1, banks will all be putting forward more attractive interest rates to fight for savers’ spare cash. They need to act fast!

3. Skyrocketing mortgage rates

If 12-month fixed deposit rate is already 2.8 percent and likely to be 3 percent soon, how can banks keep their fixed mortgage rate at 2.75 or 3.08 percent?

As expected, to ensure a reasonable profit margin between deposit and lending, UOB and DBS decided to cease fixed-rate home loans on September 23. Inflation, monetary tightening and rate hikes are closing in faster than what the local banks have predicted. They finally realize that fixed-rate housing loan packages don’t make sense in this soaring interest rate environment.

It looks like banks will resort to playing with SORA in floating-rate home loans in the near future. This can ensure borrowers always pay the latest and highest mortgage rates for their housing loans.

From now on, home loan borrowers would receive frequent notifications from their mortgage banks on upward revisions of mortgage rates. From my personal experience in the mid-2000s, banks would initially give one month’s notice for the revised rate. Gradually, they would date back the effective date a month earlier. This gave mortgagors no time for repricing or refinancing and they were obliged to pay higher monthly installment as requested.

After all, banks want more people to hand in their money now. Borrowers (both individuals and companies) must be prepared to pay higher and higher interest and repayment. Alternatively, they can opt to pay back their loan in full.

How long will borrowers continue to suffer? Analysts expect Fed to end rate hikes mid to end of 2023. As Fed’s chairman Powell said, “We have got to get inflation behind us. I wish there were a painless way to do that. There isn’t.”

4. Tightening on financing

Powell also warned that recession and housing market correction are on their way.

“The chances of a soft landing are likely to diminish. No one knows whether this process will lead to a recession or, if so, how significant that recession would be.”

“We probably in the housing market have to go through a correction to get back to that place. From a sort of business cycle standpoint, this difficult correction should put the housing market back into better balance.”

It won’t be surprising to see banks trying to tighten borrowing soon. It will be harder to get bank financing and housing loan approval. Remember, banks lend customers umbrellas on a sunny day, but they take them back when it is pouring.

New Zealand has started hiking rates much earlier since last October. What happened there early this year can give us some hints on what is going to happen when banks start tightening borrowing.

Mortgage brokers are reporting that clients who thought they had finance in the bag are being refused, sometimes after going unconditional on purchase.

Credit in general and mortgage finance in particular has become steadily harder to get, thanks to a variety of measures by the Reserve Bank of New Zealand (RBNZ) and the major retail banks.

The credit crunch is real, says Alexander. It started hitting borrowers towards the end of last year, with banks telling customers they had previously approved that the finance was no longer available.

The human toll of the credit crunch is harsh. “I’ve had people in tears,” says Royle. “I’ve had people shouting at me. I was threatened with being sued. It’s pretty bad.”

– “Home loans crisis”, Oneroof.co.nz, 9 January 2022

The human weakness to repeat the same mistake

Recently, GuocoLand sold 84 percent of Lentor Modern at $1,856 to $2,538 psf – a record price for the district and obviously overpriced. Honestly, for buyers who pay record high psf price to settle for a small quantum, they can’t really afford private homes.

Did they notice that private home transaction volumes drop over 25 percent in first half of the year? Did that raise the red flag?

Local banks are paying saving interest rates up to 4.05 percent. Singdollar fixed deposits and Singapore Saving Bonds also offer 2.75 to 3 percent interest. These are principal-protected guaranteed return. But these homebuyers chose to part with their cash to pay stamp duties to Inland Revenue. They opted to leave their downpayment money with the developer for four to five years. The resulting high opportunity costs, together with an overpriced uncompleted property, is a formula for guaranteed loss.

Lentor Modern is likely to be another eCO or The Glades next time. A decade after their purchase, the owners of these projects launched in 2012 are still under water. This is not even counting the stamp duties, property taxes, maintenance fees, mortgages and other expenses paid over the years.

I said the same thing when I visited the eCO showflat ten years ago. Sadly, ignorant homebuyers keep repeating the same mistake. To err is human. To repeat the same mistake is a human weakness.

An observation from previous crises: Many Singaporeans lack sense of crisis. They believe that there is no need to worry too much. In case of a financial crisis, the government will come and save us. This is exactly the mentality of sleeping beauty or Cinderella waiting to be saved by Prince Charming.

People tend to emphasize on hindsight rather than foresight. When things go bad, they wonder what happened.

What we should do with our homes under inflation

I enjoy reading up on what the media outside Singapore and experts around the world talk about the economy and financial markets. Early this year, I read a CNBC article titled “A Harvard-trained economist shares his top 21 money rules: ‘Own your home’ and ‘try to buy in cash’”. Economist Laurence Kotlikoff claimed that he lives by and teaches 21 money rules. Let me end this post sharing two of his rules concerning housing needs.

1. Strive to own your home and try to buy in cash

“This is particularly the case if you’re a moderate to high earner. Having more of your money packed in your home is a way to shelter it from federal and state asset-income taxation.”

Unlike the US, we can’t save taxes by owning a home in Singapore. On the contrary, we start paying stamp duties and property taxes the moment we purchase a home.

Nonetheless, I do agree with Kotlikoff to buy our home in cash. After all, buying a home for own stay is a consumption, not an asset. Because we are paying mortgage, expenses and taxes but not generating any income from it. We all know that it is silly to pay interest to the bank for consumptions. Likewise, it is unwise to pay a bank mortgage for years.

2. Pay off your mortgage ASAP

“Mortgages are tax and financial losers. Pay them off ASAP. Think about it: If you have $100,000 that you can invest right now in a bond earning 1.5%, you’d have $1,500 in interest income over the course of a year. But if you had a $100,000 debt at a 3.2% interest that you could pay off right now, you’d save $3,200 over the course of the year in interest payments. On balance, you’d make $1,700 with no risk by investing in debt repayment rather than investing in the bond.”

I completely agree with Kotlikoff. This is especially true when governments all over the world are raising rates to beat high inflation. In our case, we paid off the mortgage of our home four years after purchase. From then on, we would never have to worry or be upset that one day the bank would take us hostage with unceasing hikes of mortgage rates.

Many homeowners are not aware of the fact that local banks do not necessarily need a Fed rate hike to raise the interest rates of housing loans. For instance, after the announcement of new property curbs in July 2018, Singapore banks priced the interest rate of their mortgage packages higher to protect themselves for slower loan growth.

Once the economy recovers, the hikes in mortgage rates can be fast and frequent. In mid-2005, I was still paying an interest rate of 1.3 percent for my rental properties. After three to four rounds of interest rate revisions, it had already gone up to 4 percent by the end of 2006.

When calculating the worst-case scenario, instead of using the arbitrary 3.5 percent interest rate from TDSR, it is better to be more conservative and use 4 percent for the calculation.

– Vina Ip, Behind The Scenes of The Property Market

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