Making a decision to purchase a property should never be taken lightly. A property purchase is possibly the biggest-ticket item that an individual would ever make. In this sec¬tion, Damien Fong, from Singcapital Pte Ltd., answers some of the most important issues (affordability, sourcing for a suitable mortgage plan etc.) a potential homebuyer needs to know, and offers tips on what new homeowners need to know.
iFAST:What is the best way for individuals to gauge if they can afford to buy a property?
DamIen Fong: Before one makes any decision on what type of property to purchase, it is paramount to know how much one can afford to pay. After comparing your expenses against your income, you will now have a clearer picture of just how much you have left over to finance the payment of your new home. You can then decide on the property that best meets your financial situ¬ation and family needs. Examples of income sources are employment income, trade income and so forth.
When working out your current and future income, it is safer to take a conservative approach. Even if you now have a stable source of income, there may be changes that would affect your income flow, for example, a job change, sudden loss of one source of income, income fluctuations if part of your income comes from sales commission, or other less stable income sources. You should set aside a sum of money to take care of such contingencies.
After working out your Income and Expenses, you can then work out your Debt Servicing Ratio (DSR) which is often used by banks to access whether a loan application can be approved. DSR is the percentage of the borrower's total monthly financial commitment against his monthly income and it will determine the loan quantum to be granted. The acceptable DSR varies from bank to bank, but it is usually in the region of 40% to 50%.
Whether banks will approve a loan application will largely depend on whether the borrower would have the money to repay a loan in the future. Banks will usually examine the current mar¬ket value of the property (if any); your income; your employment history; your assets and liabilities; the total equity which you are committing to the property, and your age.
It is advisable to seek consultation from an independent financial adviser or mortgage broker as they will be able to pro¬vide you independent and unbiased mortgage planning advice on whether you can afford to buy a property. They can also help you in getting in-principle approval of your home loan eligibility before putting the downpayment for your big ticket purchase.
iFAST: Is it a good idea to repay off the mortgage loan as soon as possible?
DF: The advantage of repaying off the mortgage loan as soon as possible is that when you repay early, you reduce your borrowing, and that reduces the interest you must pay to the bank.
Whether you should repay the loan sooner, rather than later, actually depends a lot on what you are doing with your cash or CPF monies
If you can invest the money with better returns over and above the mortgage loan interest, then it is wise to use your money to generate more returns, for example, by buying unit trusts or shares (ideally when the buying price is low and the future potential upside is there). Mortgage loan is considered as good debt if you can have better returns from cash and CPF monies.
Hypothetically, with an interest of 7% investment returns versus 4% mortgage loan interest, it may seem attractive to pay off your mortgage loan earlier, because the net interest difference is effectively 3% positive growth, assuming that you have the same amount of cash as your loan.
However if the investment return is not high, then, it is worthwhile to consider paying off the mortgage with high¬er monthly installments, so that the interest incurred over a shorter period is not excessively high.
In Singapore, personal loans, renovation loans, credit card loans all charge interest ranging from 8% to 24% per annum. None come close to a home loan's low interest rate.
iFAST: How about homeowners who use their CPF monies to repay their mortgage loans?
DF: For homeowners who use CPF for repayment, there are two important considerations to take note of.
Firstly, by not paying off your home loan and thus, not depleting your CPF account, you can actually keep a reserve in your CPF ordinary account. If you or your spouse have a period of unemployment and cannot make CPF contribu¬tions, you may need that cushion. Think of it as ‘homemade insurance' against a home loan default. Secondly, if you make the extra home loan payments from your CPF account, it will mean that the CPF withdrawal limit will be reached faster.
Once that happens, it disallows the use of your CPF ac¬count for home loan payments. You must then use cash for loan repayments, which may affect your cash flow at that time. Then, to keep your home and avoid defaulting on your home loan, you may have to cut back on other cash expenditures, like food and clothing purchases. iFAST: What tips can you offer readers who are sourcing for a suitable mortgage plan? DF: Before taking up any mortgage loan, it is important to examine the terms and conditions of the loan. Some basics that a borrower should know about are:
i. Interest Rate In Singapore, banks typically offer mortgage loans with fixed interest rates in the first two to three years and vari¬able interest rates thereafter, or other combinations of fixed and variable rates.
A fixed-rate loan charges the same rate of interest through¬out the duration of the loan. You know exactly how much you'd have to pay monthly. But your payments won't be reduced when interest rates fall. However, payments won't be increased either if interest rates rise.
A variable-rate loan is typically pegged at a fixed "spread" (certain percentage points) above the bank's prime rate. The prime rate is the interest rate charged by the bank to its best and most credit-worthy customers. If interest rates go up, so do your monthly mortgage payments. If interest rates drop, you save money with lower payments.
ii. Loan Repayment Period Depending on the borrower's age, housing loans can stretch up to 30 years or more. A longer repayment period means you'll be paying lower installments every month but the total interest payment will be higher.
If you use CPF to repay the housing loan, it would be ideal to pay off the mortgage or maximise the CPF withdrawal limit by the time you reach 55. This is because of the lower CPF contribution rates for workers above 55. You should also note that the contribution rates for workers above 50 to 55 are lower than for those below 50.
iii. Interest Computation The cost of a loan largely depends on the loan repayment period, interest rate and how the interest is computed. In general, the interest charged will be lower for monthly rest, and higher for annual rest. A useful rule of thumb: The more frequently the interest is computed, the better.
iv. Penalty for Early Repayment Some homebuyers may want to pay their mortgage early, partially or fully, to save on interest. However, banks may charge them a fee, known as a pre-payment penalty. The penalty varies among banks (eg. it could range from 0.5% to 1.5% of the loan principal, if repayment is made in the first few years of the loan, within the pre-payment period).
This penalty is designed to persuade homeowners to con¬tinue to pay interest for a certain period, instead of paying off their loan early. Banks impose such penalties to ensure they have an opportunity to recover their costs on the par¬ticular deal that they gave to homebuyers.
iFAST: Would you advise potential homebuyers to take up a fixed or variable rate mortgage plan?
DF: Since mortgage loans are a leveraging tool for home own¬ers to be able to complete their desired home purchase, the most important feature is the interest rate and how these rates will change.
Having a fixed rate package will give homeowners peace of mind during volatile interest-rate environment, but such pack¬ages come with a higher premium (i.e. higher interest rates) as there is security and peace of mind.
For homeowners who are willing to take the risk of interest rate fluctuations, or who want to have the flexibility to deter¬mine when to pay down or fully pay off the mortgage loan, then variable rate packages would suit their needs.
During the first three quarters of 2008, many homeown¬ers in Singapore prefer the variable 3-month SIBOR package because it was the cheapest. As the financial crisis deepens, many countries, including Singapore, have seen borrowing rates shooting up, due to the seizing up of the available credit in the global markets. In such times, many homeowners would be more cautious and prefer the 12-month SIBOR or fixed rate packages.
Tips for New Homeowners
Getting a new property and a mortgage loan can be an exhausting procedure. Besides being excited about your new dream home purchase, arranging the logistics for house moving and so forth, it is important to ensure ease in your financial well-being and take note of the following essential items that new homeowners should have:
i. Mortgage Loan Insurance Mortgage loan insurance is provided by many insurance companies to safeguard your home and family against the unexpected, so that they will not be burdened with mortgage repayments or face the possibility of losing their home. Most mortgage loan insurances allow one to have a single plan that provides life coverage for joint homeowners. Such a plan takes care of unpaid home repayments, should any unforeseen event such as death or total and permanent dis¬ability happen to any one of the homeowners.
Most plans provide coverage for a shorter premium payment period. For example, some policies require you to pay premiums for only 25 years if you have undertaken a 30-year home loan. That gives you 5 years of free coverage.
Other features available in mortgage loan insurance is portable coverage, to allow the remaining terms of an existing coverage to be used for a new mortgage loan, should you decide to sell your property or fully redeem your existing loan amount.
ii. Refinance Early and Often There is a substantial difference between the banks' first and third-year interest rates. This difference is the minimum you can save by refinancing your home loan. It could be more since banks often charge rates that are higher than their advertised loan rates. Banks have said they are under no obligation to offer home loans at their low advertised rates for years 1, 2 and 3 of variable rate loans and those rates can increase at any time.
Therefore, it is important to review your home loan once every few years to see if you can get a better deal by refinanc¬ing, particularly so after your lock-in period.
If your lock-in period ends this year, you can look to refinancing in 2010 and then again in 2013, etc. "Every few years" is the recommended interval in the Consumer Guide to Home Loans by the Association of Banks in Singapore (ABS).
iii. Monitor the Changes in Interest Rates Do not be penny wise, pound foolish. A 0.1% change in interest rate could mean thousands of dollars in savings or more, especially if your loan amount is large (more than $1 million).
For homeowners who take up the variable interest rate packages, the need to monitor the home loan interest rates is even more essential in volatile market conditions. Interbank rates move daily and hence could affect your monthly installments, depending on your loan package terms. Interest rates will only be repriced according to the interest period used. For example, for a three-month SIBOR rate package, repricing is done once every quarter.
The prospect of low interest rates has also opened a window for homeowners looking to lock in low home loan rates. As interest rates move in cycles, the window of opportunity for homeowners to lock in rates may not stay open for long.
iv. Write or Update Your Will With the new purchase of your dream home, there will be a significant change in the composition of your assets. Therefore, you may wish to write or update your Will to reflect the changes.
A Will is a document which provides for the administration and distribution of what is owned by you, among people whom you desire to have a share or shares of your estate/assets after your death. Essentially, a Will is your expressed intention of what should be done with your property (e.g. movable and immovable assets) after your death.The iFAST Editorial Team is part of iFAST Central, Singapore's foremost wealth management platform for financial advisory companies.
iFAST Central provides services to more than 50 financial advisory companies, exempt financial advisers and financial institutions, and over 2,500 financial adviser representatives. Damien Fong is Financial Advisor Director at Singcapital Pte Ltd, a financial advisory company.
