ST : The dollars and sense of home loans

Nov 22, 2009

The dollars and sense of home loans

Get a package that matches your income profile and appetite for risk

By Lorna Tan, Senior Correspondent

Home buyers were recently advised not to throw caution to the wind in their anticipation of fulfilling the Singapore dream of snapping up a private unit.

The Monetary Authority of Singapore (MAS) earlier this month flagged two scenarios in which the private property sector could falter. Lately, it has levelled off somewhat, after a strong rebound.

MAS warned that property buyers could not assume that interest rates on home loans will stay at their current rock bottom levels indefinitely.

If the economy rebounds, interest rates are more likely to rise over the longer term, MAS cautioned.

This, in turn, would drive up monthly instalments on home loans that are not fixed.

If that happens, any home borrower who over-extended himself with a big loan could face serious problems.

The second scenario that MAS laid out: Home buyers could suffer losses from falling home prices as a result of a possible market correction if economic growth proves weaker than expected.

The Sunday Times takes a closer look at key factors to weigh up when taking out a home loan.

Affordability issues

In order to ensure prudent financial planning, Mr Dennis Ng, spokesman for www.HousingLoanSG.com - a mortgage consultancy portal - suggests that home buyers track their total monthly debt repayment obligations.

These repayments should not exceed 35 per cent of their household income.

For example, suppose your car loan instalment is $800, other monthly bills are $1,200 and your housing loan instalment is $3,000. That adds up to a total monthly debt repayment of $5,000.

Assume a monthly household income of $10,000.

That means half your income is going into debts. In the language of financial experts, that is called a debt-servicing ratio of 50 per cent.

That is not advisable as it is well above the maximum recommended debt-servicing ratio of 35 per cent.

Mortgage consultancy firm Global Creatif Financial helps its clients work out the maximum amount they can borrow. Firstly, it takes into account its

clients' individual and/or combined income (with spouse) derived from employment, trade, property or other income.

This amount would then be used to deduct monthly commitments including mortgage loans, car loans, bank loans, overdraft and credit card bills, said its managing director Annie Lim.

From there, Global Creatif calculates how much cash the client has left after fulfilling his monthly obligations. Using a desired loan term and an applied interest rate, it calculates the lump sum that the client can potentially borrow.

Another tip from Mr Ng is that prospective home buyers should not assess the affordability of a home they are eyeing by using current low interest rates.

Before the downturn in 2007, home loan interest rates were hovering at a higher rate of about 4 per cent.

So to be prudent, home buyers should calculate their instalments based on a higher interest rate of, say, 4 per cent instead. This would give them a better sense of whether they could afford the instalments if rates change.

Home buyers should set aside sufficient funds to meet future instalments should interest rates move up.

One's long-term repayment ability should take into account the stability of your source of income and the available Central Provident Fund (CPF) savings for the down payment and monthly loan servicing, said a spokesman for United Overseas Bank (UOB).

Consider a 25-year housing loan of $500,000 at a current rate of 2 per cent.

If indeed rates rise to 4 per cent, then monthly mortgage instalments will jump 24.5 per cent or about $520.

Using the same rate revision, if the loan is a higher $800,000, the hike in monthly instalments is about $830.

If the property is meant for investment and you are using the rental earned to fund your monthly loan instalments, you might want to factor in a possible drop in rental rates, added Mr Ng.

This is because rental rates fluctuate and it is only prudent to be prepared for the possibility of lower rental income to ensure you can still afford the instalments if rental rates fall.

Mr Ng advised home buyers to factor in a possible 10 to 20 per cent drop in rental.

Let's assume that the property is rented out at $3,000 a month. Rental falls of 10 and 20 per cent translate to lower rentals of $2,700 and $2,400, respectively.

Whether you are buying a house to live in or as an investment, it is prudent to have sufficient cash or CPF savings on standby to pay for at least six months of housing loan instalments in the event of unforeseen circumstances.

This means that if your loan instalment is $3,000, you should have $18,000 in cash and/or CPF monies set aside to cover six months of instalments.

Interest rates movement

Financial experts generally believe that home loan rates will stay low for the next six to 12 months.

Singapore home loan interest rates are very much affected by the Singapore Inter-bank Offered Rate (Sibor), pointed out Mr Ng. 'Sibor is in turn affected by two factors, United States Federal Reserve interest rates and the liquidity in the Singapore banking system. And the US has indicated it is likely to keep interest rates low for the time being,' he said.

Sibor is the interest rate at which banks lend to one another and is partly influenced by the supply of and demand for funds.

UOB said it expects Sibor rates to remain steady at the current level of 0.7 per cent for the next six months.

However, in the event that the US economy recovers, the US Federal Reserve might increase interest rates. If that happens in, say, about a year's time, interest rates here would likely rise as well.

Mr Ng recalled that Sibor was 3.58 per cent in 2007 and above 2 per cent last year. It dropped below 1 per cent only this year when the US cut interest rates to a historic low of 0.25 per cent. For the last 10 months, it has been about 0.7 per cent. As a result, some consumers may have the misconception that Sibor is always below 1 per cent.

'Consumers need to be mentally prepared for Sibor to go up to 2 per cent in more than one year's time,' he cautioned.

Another indication that home loan rates are likely to remain low, at least in the coming months, is the introduction of low one-year fixed rate packages by the financial institutions, said Ms Lim.

'The general sentiment in the market is that rates will remain low for the next 12 months,' she said.

Whether rates will indeed start creeping upwards a year from now depends on how long it takes for the global economy to right itself, but Ms Lim is certain that rates will move upwards more than three years from now.

Fixed or variable home loan packages

Naturally, the benefit of a fixed package is certainty: You know how much your instalments are for a set period.

The key difference between most fixed rate and variable packages is that the former comes with a lock-in period where you are penalised for any premature exit from the package.

Variable packages usually do not impose a lock-in period. Therefore they are recommended for clients who are not sure if they would be holding on to their properties. A no-lock-in package is deemed to be more suitable as the home buyer is not slapped with a penalty payment if he sells his property and redeems his loan. Also, variable packages tend to feature lower interest rates than most fixed rate packages, noted Ms Lim.

'These variable packages are also suitable for clients who feel that they are comfortable with any short-term fluctuations and/or feel that rates will generally remain low in the short term,' she added.

However, a variable rate, as the name implies, means that the bank can change the interest rate any time. For example, a three-month rate would re-set every three months. At the end of each three-month period, it could be higher or lower and you would pay more or less accordingly.

Fixed rate packages are suitable for clients who want certainty and peace of mind, and are not comfortable with rate fluctuations.

If you are unlikely to sell your house in the next three years, Mr Ng suggested that now might be a good time to lock in the low interest rates. You might want to consider fixing interest rates for the next two to three years.

Looking at present circumstances, both Mr Ng and Ms Lim would go for variable packages with no lock-in, as the sentiment is that rates would remain low at least for the next one year.

'Since Sibor is unlikely to go up in the next six to 12 months, one might be better off opting for a one-month or three-month Sibor package. In the event that the Sibor starts rising, one can opt to switch to a 12-month Sibor package,' said Mr Ng.

One-month Sibor is currently at 0.4375 per cent, three-month Sibor is 0.68 per cent while 12-month Sibor is 0.9 per cent. So if you choose the latter, you might end up paying more interest while interest rates are still low.

lorna@sph.com.sg