By Alvin Lock (guest contributor)
In this article I want to shed some light into several misbeliefs we often have about home loans. I hope it’ll help make property financing and refinancing decisions easier for everyone.
Myth #1 – The more I borrow, the more I pay
If you are into investing, you may have heard of the mantra, ‘cash is king’. Here’s the thing: By taking up a loan, you free up truckloads of cash. At a 1+% interest rate currently, home loan interest rates are easily lower than most investment returns. Take for instance the Singapore stock market, which has yielded 8.4% on average over the past 10 years. This is almost 8 times the home loan interest rate! Shouldn’t you be thinking of freeing up your cash?
Myth #2 – The HDB mortgage interest rate will always be at 2.6%
I hate to burst your bubble, but the common saying “change is the only constant” also applies to the 2.6% interest rate of the HDB loan. The HDB loan interest rate is derived based on the prevailing CPF ordinary account (OA) interest rate, plus a margin of 0.1%.
So this means HDB interest rate may vary based on the market situation. For example, in the first half of 1999, the CPF OA interest rate went up to 4.41%. Consequently, the HDB loan interest rate was almost twice what it is now. It is important to understand the risks involved when going into any type of loan and to be prepared for potential fluctuations.
Myth #3 – I should take a shorter loan tenor and pay it down faster so I will pay a lot less interest
Let’s begin by illustrating a simple example of the additional interest payable across two different loan tenors for the same loan amount, at the same interest rate.
Loan Amount: $500,000
Interest Rate: 1.5% p.a.
Loan Tenor A: 25 Years
Loan Tenor B: 15 Years
As can be seen from the simple table above, you would only pay an additional of $900 at the end of the third year if you opt for a 25-year loan tenure. At the end of five years, it is $2,500 more, and even at the 10-year mark, the additional installment annually is only $1,000, which is 0.2% of the total loan amount.
By saving this small amount, you’d have to fork out $1,100 more per month, and $13,200 per year if you were to opt for a shorter loan tenor. Unless you are very confident about your career/business prospects and income profile, this additional $1,100 per month may be a strain on your cash flow.
Bear in mind how financial institutions operate. When you are doing well, everyone is eager to lend you more money (even though you don’t need it). During bad times, they flee faster than a kid chasing an ice cream truck. Your mom didn’t lie to you about saving for the rainy day.
But what if you strike Toto or 4D (i.e. get rich)? Fret not. Instead of taking the risky short loan tenor, you can always review your loan portfolio every two to three years and make a lump sum payment if it is within your means.
Myth #4 – I love my bank and my bank loves me
We understand that your bank may treat you well today, as the market is highly competitive for home loans. But don’t forget that at the end of the day, the banks will want the best for themselves.
The truth is that there is never going to be a single financing institution that will forever offer you the best financing/refinancing packages. Do yourself a favour and do some research. This is to ensure that your bank isn’t short-changing you of the best terms available, as compared to their competitors.
Here’s another pro tip: Apart from your home loans, you may also want to reconsider keeping all your banking relationships with just one bank. The innocent looking “All Monies Guarantee”, a clause found in most loan contracts, gives the bank the right to take the money from your cash and deposits, liquidate your investments, etc. for immediate repayments should you default on your loans. It goes without saying that you are definitely risking it all by parking all banking relationships with one institution.
Myth #5 – I should use my CPF monies to pay off my home loan
If you find yourself thinking about using CPF to pay off your home loan, think about the following questions:
- Do I have spare cash?
- Can that cash generate better returns?
The amount in your CPF Ordinary Account (OA) earns a risk-free interest rate of 2.5% p.a. Come to think of it, are there any other investment products that can promise you the same rates (or more) with absolutely no risk? As a comparison, DBS’s savings account interest rate is 0.05% for the first $250,000.
If you can’t think of anything else, then of course the sensible decision would be to pay up your home loans using your cash on hand. Additionally, the 2.5% interest-generating balance can and will definitely help to tide you through times of need. Be it for a change of job, when dealing with unforeseen medical emergencies or when you simply need to take a break from work, your CPF can take care of your home loans, assuming you have sufficient balance in your account to do so. Again, prepare for the rainy day!
Myth #6 – I risk losing my property if I re-mortgage it
This is slightly more relevant for private property owners. The idea of having to re-mortgage, cash out, or apply for an equity term loan for your property shouldn’t be a taboo. This is especially so if you have fully paid off your property, or are almost getting there.
While it may be comfortable for you to have that peace of mind, think of the opportunities you are missing out on. When you cash out on your property, especially when there is an increase in value (and when home loan interest rates are still low), the value of cashing out becomes evident if you have other debts to deal with. Take for example:
From the above table, you should be able to conclude that the borrowing cost of a home loan is a fraction of the rates charged for car loans and personal loans. Home loans, unlike other loans, also go through an amortization schedule instead of a flat interest rate. You can even enjoy a longer loan tenor of up to age 75, or a maximum of 35 years, whichever is lower. No doubt, this would help to ease your cash flow.
For those of us with a bigger risk appetite, cashing out allows us to jump at business or investment opportunities. Take for example the property investors who made a fortune out of the 2008 global financial crisis through property “flipping”.
By cashing out your property, you can take advantage of the next opportunity that arises. The last thing you want is to be restricted by the lack of funds despite affordable borrowing costs.
Myth #7 – Married couples should do everything together
This myth is for the married couples. While you may share everything with each other, having a home liability together is definitely a no go. With the exception of combining your incomes to qualify for a specific loan amount, you won’t be able to borrow as much when it comes to purchasing your second or third property, simply because of the maximum loan-to-value ratio.
The solution to get around this would be to:
- Apply for the home ownership in joint names, BUT
- Apply for the home loan in a single name.
Fret not, you can still use either of your CPF monies to make down payments or even to service monthly loan instalments.
Summary: What the Savvy Property Owner does when borrowing
If I have identified a potential property investment opportunity today, I would check through the financing packages available from banks and select a suitable option, either with a two to three year lock in period if the rates are attractive or ideally no lock in at all.
I would then apply for the maximum loan quantum and tenor I can qualify for to manage my financing comfortably without overstretching my cashflow, and review my loan portfolio every two to three years.
I would leave my CPF monies alone to let them earn risk free returns of 2.5% p.a. unless I have better use of my spare cash for other investments or for a new property. I would also check periodically to see if I have positive equity that I can extract from my property through a cash out, and I would not take a property loan commitment with my spouse unless it was necessary.
Alvin, from Redbrick Mortgage Advisory, has more than 11 years of experience and track record in Retail and Private Banking. His core expertise encompasses a full spectrum of wealth management services including Investment Advisory, Portfolio Management and Financing, Margin Trading, Legacy Planning, and Property Loans. To get a free consultation on your new loan or refinancing needs, please head to www.propwise.sg/mortgage/