Borrow big to pay for your home? It may not be foolhardy

Borrow big to pay for your home? It may not be foolhardy

Taking out a huge real estate loan seems risky, but it may sometimes be a better option

By Dennis Chan, Deputy Money Editor

– ILLUSTRATION: MARK M DIZON

After my last Small Change column was published, a colleague came up to me and said: ‘Property isn’t a high-risk investment.
‘In fact, it appeals to a low-risk investor like me who doesn’t know enough to invest in stocks and shares. What- ever spare cash I have, I use it to pay off my housing loan.’

I had argued in my column that property investment is a high-risk, high-reward game, using the example of a $1 million home bought with $100,000 cash and $900,000 borrowed.

If the price of the home rises by 10 per cent, it will be worth $1.1 million and the investor would have doubled his initial capital. But if it were to fall by an equal amount, his capital would have been wiped out.

So who’s right?

Both of us are.

Residential property is a familiar investment to many Singaporeans since home ownership became the cornerstone of government policy in the mid-1960s.

Indeed, whether you are a sophisticated investor or one wet behind the ears, you can’t go wrong buying a home as a long-term investment in land-scarce Singapore. Seen in this light, it is a safe investment.

It becomes highly risky only when one buys a second, third or fourth property leveraging on borrowings and relying substantially on rental incomes to service the loans.

On reflection, I realise there are many people like my colleague who pay down their housing loans very early, and take pride in doing so.

This sentiment is entirely understandable. Many of us take home ownership for granted, thanks to the Government’s hugely successful public housing programme.

But for the older generation and the one before that, the fear of not having a roof over one’s head was very real.

To them, it’s an achievement to own a fully paid-up home as quickly as possible.

To these people, I say: ‘Go ahead, if you can afford it.’

‘What do you mean?’ you may retort. ‘If I take my spare cash to repay my home loan, surely I can afford it.’

Not necessarily.

There is a cost in putting too much equity into a home purchase.

To illustrate, let’s take the example of two young couples - X and Y - who buy a Housing Board resale flat at the market valuation price of $500,000.

Let’s assume each couple have savings totalling $150,000 in their Central Provident Fund Ordinary Accounts (OA) and a combined monthly income of $6,000. Both are are entitled to an HDB concessionary loan - currently at 2.6 per cent a year.

Under the rules, buyers are allowed to pay 10 per cent as down payment and borrow the remaining 90 per cent to finance their purchase.

Couple X, being very prudent, choose to use up all their OA balances to pay for their home. They take out a 30-year, $350,000 loan to finance the rest. For simplicity’s sake, let’s assume the entire $150,000 goes towards paying the down payment. In reality, the actual amount will be less, minus the money to pay stamp duty, home protection scheme insurance and legal fees.

Couple Y, being more gung-ho, decide to pay the minimum down payment of 10 per cent, which works out to $50,000. They, too, take a 30-year loan but for a higher amount of $450,000.

Using a financial calculator, Couple X and Couple Y’s monthly loan instalments work out to about $1,400 and $1,800 respectively.

Couple X’s monthly CPF OA contribution totalling $1,380 is almost just about able to cover fully their monthly instalment whereas Couple Y would have to top up an additional $420 in cash.

At the end of 30 years, Couple X will have paid a total of $504,000 to repay their $350,000 loan whereas Couple Y will have coughed out $648,000 on their $450,000 loan.

Interest charges by Couple X and Couple Y over this period work out to $154,000 and $198,000 respectively.

On the face of it, Couple X seem far better off. Their monthly repayment is lower and they incur $44,000 less in interest charges.

On closer inspection, the benefits of borrowing less are not that clear cut.

Firstly, one needs to take into account that Couple Y kept $100,000 of their OAs from the start. This means they get to earn annual interest income, which Couple X will forgo until their CPF contributions from income accumulate again.

Interest payment for OA balances is 2.5 per cent a year. For the first $20,000, a higher interest of 3.5 per cent applies.

Insofar as the first $20,000 is concerned, it is better to leave the money untouched and earning 3.5 per cent a year than to use it to pay off an HDB loan that charges 2.6 per cent per annum.

As for amounts greater than $20,000, one doesn’t lose much either since the difference between interest payable on an HDB loan and earned for money kept in the OA is a mere 0.1 percentage point (2.6 per cent - 2.5 per cent).

Secondly, keeping substantial savings in the OA can be an important buffer to cope with a temporary loss of income.

The sum of $100,000 is equivalent to five years’ worth of monthly repayments. So even if one or both persons who make up Couple Y were to stop working for some reason or quit to start a family or take a sabbatical, they can continue to service their loan entirely from their OAs for about five years while looking for their next job.

Couple X, on the other hand, will have no such luxury. They will be forced to tap their cash savings immediately in similar circumstances.

Thirdly, having some spare savings in the OA opens up investment opportunities and flexibility.

Bear in mind that the HDB loan at 2.6 per cent is really cheap money.

Last year, insurer Aviva offered an endowment plan called Big e that paid up to 3.5 per cent in interest a year. The plan, which guaranteed a return higher than 2.5 per cent, has since been discontinued.

However, such opportunities that offer low-risk returns based on positive interest differential (3.5 per cent - 2.6 per cent) can be expected to surface from time to time.

For those with a higher risk appetite, there are also numerous CPF-approved investments that have a track record of generating annual returns in excess of 5 per cent over the mid to long term.

Although I used the HDB flat purchase as an example, the argument is also valid for private property purchases, given the current low interest rate environment.

Fourthly, if your flat is rented out, you can apply to the taxman to offset your rental income with the interest paid on the loan. So the bigger the loan amount, the higher will be the interest offset.

Finally, if all else fails and there is no reasonable opportunity to earn a better return, there is always the option of using your OA balance to pay down your housing debt at any time.

Bear in mind this option is irreversible. You can pay down a housing loan but you cannot top it up.

Do note that if you take an HDB loan, you must ‘invest’ your excess OA balance before your first appointment with the board.

That is because HDB will exhaust your OA for down payment - minus the amount for stamp duty, legal fees and home protection insurance - before granting you a loan.

In the earlier example, Couple Y would have to withdraw from their OAs the sum of $100,000 - or an appropriate amount after taking into account the 10 per cent down payment and ancillary charges - and put it into a CPF-approved investment.

If the investment is meant to be a temporary one, choosing a low-risk, low-return fund like DBS Enhanced Income Fund would be appropriate.

After the first appointment, you may liquidate the investment and return the proceeds to your OA.

Be aware that this ’round tripping’ is not cost free as agent bank fees and sales charges apply. These charges are nominal though.

To sum up, taking on a big housing debt is not necessarily a bad thing. In certain circumstances, it may even be the prudent thing to do.

Whether you choose to be Couple X or Couple Y, you must do your sums and feel comfortable with the plan.

Safe long-term bet
Whether you are a sophisticated investor or one wet behind the ears, you can’t go wrong buying a home as a long-term investment in land-scarce Singapore. Seen in this light, it is a safe investment.

It only becomes highly risky when one buys a second, third or fourth property leveraging on borrowings and relying substantially on rental incomes to service the loans.

Source : Straits Times - 03 Aug 2008

Singapore Property - Buy, Sell, Rent, Invest

Mindy Yong

(+65)91002985

mindy@mindyyong.com

Singapore HDB rents still well on the rise

Singapore HDB rents still well on the rise

Demand still there with expats on smaller housing allowances and those priced out of condo market

By Fiona Chan, PROPERTY CORRESPONDENT

‘Those who used to be renting a condo at $2,000 to $2,500 a month find they have very few options when they want to renew their lease, because their landlords have increased rents to $3,000 to $3,500.’

MR CHRIS KOH, director of real estate agency Dennis Wee Properties, on rising demand for HDB flats

Rents at many condominiums in Singapore appear to be peaking, but landlords of Housing Board flats are still riding the cash wave.
HDB rents continued their steady rise in the second quarter of this year, increasing across all flat types and most towns as renters sought cheaper alternatives to increasingly costly condos.

Owners of four-room flats benefited the most, with average monthly rents climbing almost 10 per cent to $1,750, from $1,600 in the previous three months, according to the latest data from HDB.

In terms of towns, Bukit Batok, Central, Serangoon and Hougang saw major rent rises across all flat types.

Generally, HDB rents have been increasing because rents of private apartments ‘have hit a level too high for many to afford’, said Mr Chris Koh, director of real estate agency Dennis Wee Properties.

‘Those who used to be renting a condo at $2,000 to $2,500 a month find they have very few options when they want to renew their lease because their landlords have increased rents to $3,000 to $3,500.’

Many of these displaced tenants work for smaller firms and do not have the flexibility of higher rent budgets, so they turn to HDB flats, Mr Koh said.

Some new tenants are also S-pass holders with smaller budgets that can only fit HDB flats rather than condos, added Dr Tan Tee Khoon, head of KF Property Network, a subsidiary of Knight Frank.

He also noted that the stock of HDB flats for rent remains fairly constant, unlike that of condos. Supply of HDB flats is also limited because of the conditions imposed on owners who want to lease out their flats.

Rising across the board

Between April and June, eight out of every 10 towns saw higher rents for four-room flats, with Jurong East experiencing jumps of up to 21 per cent.

The priciest place to rent a four-room flat is now Bukit Merah, where the average monthly rent is $2,300. Close behind are flats in the Central area, Toa Payoh and Bishan, which command $2,000 or more.

‘Bukit Merah has become popular with foreign nurses who work at Singapore General Hospital, and Jurong East is getting a lot of foreign students from Nanyang Technological University and foreign factory workers working in the west,’ explained Mr Koh.

He added that Toa Payoh seems to attract expatriates working in the city as well as foreign nurses from Thomson Medical Centre and Mt Alvernia Hospital.

Landlords of other types of HDB flats are also seeing a tidy profit. Monthly rents of three-room and five-room flats went up by $100 on average to $1,500 and $1,900 respectively.

For three-room flats, the biggest growth was in Hougang, where rents soared 40 per cent to $1,400 a month. They also saw sizeable increases of more than 10 per cent in Geylang, Bukit Batok, Ang Mo Kio, Serangoon and the Central area.

For five-room flats, Bukit Timah, Jurong West and Hougang were especially in demand. But the most expensive five-room flats are still in Marine Parade and Central, where they go for $2,550 and $2,400 a month, respectively.

Steady in the short term

Rentals for HDB flats are likely to hold steady or even rise for the rest of the year as they remain much more affordable than condos, predicted Mr Koh.

KF’s Dr Tan also believes HDB rents will rise a further 10 to 15 per cent in the next six months.

‘As more new condos are completed next year and the year after, rents of condos will ease and then only will we see HDB rents easing off as tenants will have more choices,’ Mr Koh said.

Source : Straits Times - 03 Aug 2008

Singapore Property - Buy, Sell, Rent, Invest

Mindy Yong

(+65)91002985

mindy@mindyyong.com