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Manage the impact of interest rates

After nearly a decade of lingering at low levels, interest rates have been on the rise for the past year, and economists had forecast continuing increases. Over the past several weeks, however, rates have belied those expectations and flattened or even declined.

After nearly a decade of lingering at low levels, interest rates have been on the rise for the past year, and economists had forecast continuing increases. Over the past several weeks, however, rates have belied those expectations and flattened or even declined.

Since interest rates have a large impact on almost everyone’s pocketbook, it is timely to look at how to manage the impact of those rate changes.

WHERE ARE INTEREST RATES HEADED?

After the US Federal Reserve increased its Federal Funds rate in December last year, a move which helped push Singapore’s rates upwards as well, many economists were convinced that interest rates were headed steadily upwards. Recently, however, views have changed. Economic weaknesses ranging from slower gross domestic growth to lower commodity prices and further risks for the Chinese economy have caused uncertainty about the outlook for interest rates.

Even though there is less certainty, most economists still expect interest rates to rise. UOB wrote that it expects interest rates to trend higher, with the benchmark three-month Singapore Interbank Offered Rate (SIBOR) reaching about 1.8 per cent by year-end, and OCBC similarly expects a higher interest rate environment. iCompareLoan.com Chief Mortgage Consultant Paul Ho concurs, forecasting that one-month SIBOR rates could rise from about 1.25 per cent now to 3 per cent by 2018.

INVESTORS

Higher interest rates can be good news for savers. Interest rates on one-year time deposits, for example, have risen to nearly 2 per cent. Since rates may rise further, savers may be better off depositing part of their money each month to take advantage of changes rather than investing everything all at once.

For investors in bonds or shares, on the other hand, it is harder to decide what to do next.

As interest rates rise, bond prices move in the opposite direction and head downwards. Investors in bonds or bond unit trusts may well see the value of their investments fluctuate as interest rates go up or down. These investors may be better off selecting bonds with shorter durations, because prices tend to be less sensitive to changes in interest rates. Merrill Lynch also suggests creating a “laddered” portfolio with bonds that mature in succession over time, so that the proceeds of current bonds can be reinvested at higher yields as each bond matures, or investing in fixed-maturity exchange-traded funds (ETFs) or inflation-protected bonds, such as Singapore Savings Bonds.

Investors in shares could sometimes benefit by investing in sectors that profit from rising rates. Shares of banks often gain, for instance, because the rates banks pay on deposits rise more slowly than the rates they charge for loans. The impact of interest rates on most companies have been greatly overshadowed by factors such as a slowing economy, however, so investors in shares could do better by focusing on company fundamentals rather than on interest rates.

MANAGING THE COST OF LOANS

While savers have benefitted from higher rates, borrowers are often paying more. The increases in deposit rates have led to higher rates for loans, with costs of everything from mortgages to credit cards rising. Three tactics can help borrowers in a higher interest rate environment.

The first is to take time to figure out exactly what rates they are paying and pay off loans higher rates. Credit card interest rates have risen from 24 per cent per year to as much as 28 per cent in recent years, for example, so paying off that debt can be beneficial. If you don’t have the money now, using a lower-cost instalment loan to pay off the debt could bring costs down.

Homeowners can consider locking in mortgage loan rates before they rise further. While interest rates at many banks are below the HDB concessionary interest rate of 2.6 per cent, HDB home loan rates as well as condo mortgage rates are often tied to SIBOR and have been rising. Even though it is possible that rates could drop, the consensus is for rates to rise. Taking advantage of fixed-rate loans could prevent costs from rising in the future. As Maybank puts it, “interest rates might rise tomorrow, home in on attractive rates today”.

Another solution, albeit harder, is to look at your potential borrowing needs over the coming year and take out loans sooner. If you will need a loan for a car or home renovation or another large purchase, it could be better to lock in rates now rather than later.

WHAT TO DO NEXT

There is plenty of uncertainty about interest rates, and changes in outlook occur often, so it is important to keep a close eye on where rates are headed as well as the amount of interest you are paying. Reading bank statements, watching interest rates, tracking SIBOR periodically and paying off loans or taking advantage of lower fixed loan rates can help to cope with interest rate increases and volatility.

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