Wednesday, August 09, 2006

When +1% in BLR happens

Long term interest rates that remained historically low beginning after the 1997 recession as well as relatively low inflation has propelled house prices to their new elevated levels. As inflation is taking off and persistently so, albeit it might be cost pushed rather than demand led, interest rates must rise to levels that give a positive real return and to fight inflation.

By and large, houses are mostly financed by loans, so purchases are heavily affected by interest rates. BLR currently stands at 6.75% and so far, we had witness several hikes in the OPR by Bank Negara for it to reach at this level. From hearsay as well as bankers' prediction, the hikes are going to be continuous due to the high inflation and in sight, another 0.25% is well expected.

So in my moments of idleness, I used a mortgage calculator and did a little experimentation with fictional figures to actually gauge the real financial impact that would befall salaried mortals like myself. The industry practise for calculating the maximum monthly payment and therefore the amount of eligible loan is by using 40% of one's monthly income. From a simple spreadsheet populated with off the head figures, I had managed to come out with the following conclusions.

A hike in interest rate would basically affect debtors in two ways. Increase in the monthly payment or less principal to be borrowed. A 1% increase in BLR actually makes 10.48% increase in the monthly payment. While 0.25% hike in BLR increases monthly payment by 2.569%. So there. I had never realised that one hundred basis points have such an impact to the borrowing cost. In terms of the principal, every 1% increase in BLR would strip off about 10% of the principal one would be eligible to borrow.

So, for current homeowners still paying their home loans, a 1% hike would mean they'll have to absorb the 10% increase in their monthly mortgage payment by means of cutting back from other areas. And if they can't, they'll have to sell. For new borrowers, a 10% of principal would be slashed off from their eligible loan amount. Hence, their purchasing power is directly affected.

Borrowing cost should be viewed properly before one commits to join in the race. Before they know it, an oversupply situation emerges and houses come crashing down.


Yeah I'm boring. I know.