Essential Homework Before Taking Loan

Source : The Business Times, 14 November 2007

KEVIN LAM discusses five key areas that your home loan banker would be looking very closely at

THIS has been a special year for the property market. Not since the early 1990s has there been such euphoria about the property market - long queues at property launches, stories of someone we know making fast money by 'flipping' new property purchases in a matter of weeks, even days. Many people who have yet to join the party have been wondering if they should also jump on to the property bandwagon.

With the latest government measures to discontinue the deferred payment scheme, some measure of stability should return to the market such that even as prices continue to go up given our transformation into a global city, it would rise in a more measured manner.

For those who need to think very carefully about the finer details of taking out a loan with a bank to finance what would be one of the biggest financial commitments, you may want to consider some finer details as part of your overall decision-making process.

What should I consider about buying a house and financing it?

In Singapore, we have seen two boom-and-bust cycles of property price peaks and troughs in the past 17 years. While many people may think that we are currently in the midst of a boom, many others remain cautious and conservative about making a property financing commitment, and rightly so. The first and most important thing potential home owners should be looking at when they consider buying a house and taking up a mortgage to finance it is this - are you over-stretching yourself? To answer this, you have to look at five key areas that your banker would probably be also looking very closely at:

Quantum of financing: Since July 2005, the Monetary Authority of Singapore (MAS) has liberalised the quantum of financing for housing loans, up to 90 per cent loan-to-value (LTV). This means that as a home buyer, the minimum that one needs to raise is 10 per cent of the value of the property and the cash component can be a minimum 5 per cent with the balance of 5 per cent made up from the Central Provident Fund (CPF).

Typically, because the capital and credit cost associated with granting these higher quantum loans are higher, these loans come with higher interest rates when compared to 80 per cent LTV loans. In this market, a comfortable level for financing for banks would generally be at 80 per cent quantum of financing. This means that home buyers must have a minimum of 5 per cent cash and 15 per cent CPF lump-sum from their CPF Ordinary Account. For a $1 million property, this works out to $50,000 in cash and $150,000 in CPF OA monies, or if one prefers, this amount could be paid in cash.

With more cash upfront, this is generally viewed more favourably by the banker, that is, if you could use more than the minimum 5 per cent cash. For example, if there are two borrowers looking for 90 per cent financing, both of equal standing, the one who can put up the entire 10 per cent in cash downpayment, would be better positioned from a bank's credit standpoint than the other who uses 5 per cent cash and 5 per cent CPF monies. More cash upfront shows more commitment from the potential customer, and this would generally put your financing request in a better light.

Likewise, if a potential customer has the ability to fork out up to 30 per cent or more, cash or CPF down payment, and request only 70 per cent financing, he or she can be more confident of your request for financing.

Employment profile: The potential customer's employment status is also one of the most important considerations to review when taking out a housing loan. He or she should consider the stability of his/her employment, regardless of whether the potential customer is a working employee or self-employed.

Typically two years of qualified income coming from the same employer or same source of business should be a good indication of the borrower's employment profile. On the other hand, if a borrower changes jobs frequently, even with higher income, it may be viewed by banks as being less secure and stable in employment.

Income and your CPF reserve: In home financing, one of the key commitments is to ensure that monthly housing loans instalments remain uninterrupted and consistent.

As a good rule-of-thumb, if housing loan instalments are kept to below 40 per cent of a person's monthly income, the borrower would be better positioned in his/her monthly servicing ability. This is especially so if the borrower's monthly CPF OA contribution is able to fund a good part of the housing loan instalment.

It would also be a prudent measure to have a reserve of at least six to 12 months of monthly instalments in the CPF OA. This provides more cushion should there be a change in a borrower's employment status, and he/she needs time to find another job. This means that when one uses CPF for the initial downpayment, it is important to be conservative and keep a reserve, rather than using up all of one's CPF for downpayment. As one goes through the sums for mortgage financing, one will realise that income, CPF resources, employment profile, and the quantum of financing are all inter-related. Any home buyer should sit down and work out the numbers to ask the question: 'Am I over-stretching myself financially?'

Interest rate, monthly instalment and rental yields: One of the key considerations in taking a housing loan is interest rate. However, borrowers almost always ask the wrong question with regards to interest rate. 'How low is your interest versus other banks?' is the typical question.

Consider this alternative thinking; instead of asking how low a bank's interest rates are, borrowers should seriously consider the exact opposite: 'How high can interest rates be, while I can still afford the housing loan payment? Look at the accompanying table and consider various scenarios, such as a higher interest rate (note that the SGD mortgage interest rate is one of the lowest in the region) and whether a borrower can continue to service the loan, even if interest rate would double. Not possible?

Those of us who can remember the 1990s recall that housing loan rates were once at 8 per cent. These difficult economic periods when interest went up were often accompanied by periods where people found the stability of their income at risk. So, under such circumstances, if you were to lose your job, do you have sufficient reserves to last - and for how long?

This is where the difference of taking a fixed or a floating rate should be reviewed. Floating rates, while lower, do not have the stability of fixed rate loans. So a borrower may want to consider taking a two-in-one loan where a borrower can combine both fixed and floating rate loans in one mortgaged property. For example, the UOB two-in-one loan.

With rising rental yields, many are also thinking of buying a property as an investment which they intend to rent out to cover mortgage payments. Here. the question to ask would be: 'Would I still be all right if rental should fall by half?' Rents go up quickly due to shortage of housing, especially for foreigners with good housing budgets, but they can drop as quickly if there is a downturn.

In the current climate, these may seem faraway possibilities, but whether you are buying for your own stay, or for investment - consider the various scenarios and do your sums carefully.

Your credit performance: One of the other lesser known issues one should consider before taking up a housing loan is credit performance. In Singapore, all your credit performance in terms of number of loans applied for, whether for housing, cars, credit cards or other loans is stored in the Credit Bureau. When you apply for a loan, you would have signed a consent for your bank to obtain a copy of your credit performance.

Some borrowers have been caught in a situation where they committed to a property by paying the option money, only to find that when they apply for a loan, their application is either turned down, or their request for financing reduced. This could be due the credit history, showing a habitual lateness for other loans. These information are transparent across banks, and a borrower would be advised to get a home financing in-principle approval before committing to a property. One of the ways to ensure that one is not 'caught' by credit performance is to ensure that payment is prompt in the borrower's other loan repayments.

Many people think that housing loans are commodity products, but that cannot be further from the truth. In a very competitive market like Singapore where rates are so low, banks have learnt to compete not by price competition, but through value-added features.

All said, it is key for every potential home buyer to do some homework. Ask yourself if you have the resources both now and in the future to service the mortgage for the amount of loan you intend to take to buy that property. As daunting an exercise as this may be, it is one exercise that we must spend time pondering. At the end of the day, there is no free lunch.

Kevin Lam is head, loans division, United Overseas Bank