Facing up to rising mortgage rates

Chances are, for those of us who have mortgages in Hong Kong, you would realise your latest monthly mortgage repayment has reached a record high.

The 1-month HIBOR (HK Interbank Offered Rate), which is the key benchmark rate for pricing home mortgages in Hong Kong, rose to 5.25%, as of 27 July 2023 — that’s 4 times the year-ago rate of 1.31%.

This is the result of aggressive rate hikes by the US Federal Reserve since the middle of last year with aims to tame red-hot inflation in the US. The Hong Kong Monetary Authority (HKMA) has to follow in lock-step to increase the city’s benchmark rate due to the HK dollar’s (HKD) currency peg with the US dollar (USD).

With the dramatic shift to sharply higher borrowing costs after a decade long of ultra-low interest rates, let’s look at some options on how you can better manage your mortgage payments in this rising rate environment.

Weigh pros and cons of early mortgage repayment

Given the rising mortgage rates, some may wonder if they should repay their home loans early. Here are the pros and cons you can consider in deciding whether that will be the right option for you:

Pros of early mortgage repayment

1. Save interest by paying off the loan

The logic behind early repayment is simple. By paying off your loan, you reduce your outstanding loan balance, and hence lower the total amount of interest you have to pay over the life of the loan.

For example, if you have a 30-year HK$5 million mortgage that has an outstanding term of 10 years at 3.5% interest, by repaying 10 years early, you can save close to HK$423,800 in interest. 

That said, you may notice that in this example, the interest saved represents only 14% of the total interest cost of the 30-year loan. This is because of the mechanics of loan amortisation — interest payments are front-loaded in the loan’s first 20 years, which means that near the end of the loan life you are mainly paying back the principal amount.  Hence, the repayment calculation might also depend on the remaining length of your mortgage loan life. 

2. Peace of mind

After more than a decade of low interest rates, rates are on the up as inflation is still a pressing concern for now. It might be prudent to reduce your loan now to ease off the mental pressure that comes with monthly mortgage repayments.

Cons of early mortgage repayment

1. Opportunity cost or the foregone interest that could be earned in the market

For some, an important factor in deciding whether to pay off their mortgages early, comes down to the opportunity cost of doing so. That is, they may consider the interest that could be potentially earned on the cash if it had not been used for early loan repayment.

When interest rates were at ultra-low levels in the past decade, the opportunity cost was low. In order to earn a higher return on cash, one had to take more risks by dabbling into stocks and other higher-yielding investment opportunities.  

At the current elevated interest rate levels, the opportunity cost for early repayment has also increased. Fixed deposits and other cash management products could provide yields of 5% per annum or even higher (as of end-July 2023). 

On the other hand, most mortgages in Hong Kong would have a maximum ceiling on the interest rate, which is calculated as a deduction (usually about 2%) against the bank’s Prime Lending Rate, which stands at 5.875% for most key banks in Hong Kong as of 28 July 2023.  This means that for most of us, our prevailing mortgage rate would be lower than yields offered by fixed deposits and relatively safe cash management investment products. Hence, some individuals might see it as an opportunity cost to repay the loan early, as they would be forgoing the opportunity to potentially earn a higher return via relatively low-risk investments. 

2. Reduces liquidity

Paying off your home loan early will reduce the amount of liquid cash you have on hand and potentially deplete your emergency fund. This means that if you have an urgent need for a large sum of cash in the future, due to unforeseen circumstances, you might have to consider selling your property or to take up a home equity loan.  

3. Early repayment penalty

Another thing to note is the penalty that could be incurred when you partially prepay or fully redeem the entire mortgage within the mortgage’s lock-in period, which is typically 2 to 5 years. Generally, a penalty of 1.50% will be charged on the amount prepaid, or HK$15,000 for a HK$1 million prepayment.

There might be special offers by banks that allow partial prepayments within the lock-in period, without incurring penalties. The quantum of partial prepayments varies across the banks; it ranges from around 30% to 50% of the outstanding loan amount.

Be Cash Smart: Looking into cash management products and options

A mortgage is a long-term and significant commitment. In an elevated interest rate environment, it is important to ensure that your existing cash is being worked harder to make up for the higher expense.

One way to instil discipline is to ensure that for every $1 that goes into paying your mortgage, another $1 is put to the investing grind. 

Local savvy deposit “yield hunters” have noticed that banks in Hong Kong are beginning to offer more favourable time-deposit rates after more than a decade of low interest rates. However, those of us who have mortgage obligations that are recurring monthly cash outflows might prefer to preserve our cash savings’ liquidity. In that case, you may consider other cash management options such as money market funds which could offer better liquidity and flexibility. 

It should be clearly noted that although money market funds (MMFs) are not capital-guaranteed, they generally invest in high quality money market instruments and are generally considered to have low investment risk.

On Endowus Hong Kong’s Fund Smart platform, we offer a diverse range of HKD and USD MMFs with no lock-up restrictions. Investors are free to withdraw their money from these funds at any time. 

If you would prefer an advised portfolio instead of buying single funds, consider the Endowus Cash Management model portfolios, which are designed by our Investment Office for short-term cash management and built using high-quality MMFs or ultra-short duration fixed-income funds. As of the end of July 2023, the latest projected net yields of the Endowus Cash Management model portfolios stood at 4.8%-5.2% p.a. Learn more here.

Financial planning for the long term: generating passive income for your mortgage 

Of course, while the mortgage burden hits us monthly, the reality is that it is a major long-term debt commitment and comes alongside other big-ticket expenses in life that are becoming more expensive. 

Taken in totality, it is worthwhile to look at how you are investing beyond relatively low-risk cash management products, for the pockets of cash that are not used for liquidity items, to harness the power of compounding and market premiums. 

Investors looking for passive income can consider putting money into bonds that are also rising in yields, or in dividend-paying stocks. Endowus has a whole suite of model portfolios, such as the Global model portfolios and the Passive Income model portfolios as well as tactical options through single funds on our Fund Smart platform — curated for investors to make their cash savings work harder for a more comfortable future. 

Managing property debt is one of the most important financial decisions we can make in our lives. With digital wealth platform Endowus, you can plan and manage your money by investing in low-cost money market funds and passive income portfolios seamlessly. To get started, click here.

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