By Property Soul (guest contributor)
Dollars and Sense recently published a blog post titled “Here’s the salary you need to earn to afford these homes in Singapore”. The writer of the article has the good intention to show readers what type of housing they can afford based on their monthly salary. However, income is only part of the whole picture when it comes to deciding whether you can pay up for a property.
Housing affordability is not all about income
When you apply for a housing loan, banks usually ask for your latest payslips, account statement, tax assessment, CPF contribution history, etc.The banks need to make sure that borrowers are capable of repaying their housing loan. This also serves as a proof of income when calculating the Total Debt Servicing Ratio (TDSR).
However, whether you can afford a particular housing type cannot be entirely based on your monthly salary. There are other important factors to consider too, including:
- How much cash and CPF you can use to settle the deposit, legal fee, stamp duties, renovation, etc.
- How much you can set aside for mortgage repayment after the deduction of your monthly expenses.
- How much contingency funds you have to cope with interest rate hikes, negative equity, etc.
- How stable your household income is (job stability of both husband and/or wife).
- When you purchase your property makes a big difference in the loan-to-value, buyer and seller stamp duties, etc.Comparing Dollars and Sense Affordability Table and 3-3-5 Rule
Back in June 2014, Yahoo News reposted an article from my book No B.S. Guide to Property Investment about my 3-3-5 affordability test. This has attracted tons of comments and sparked off heated debates online.
Let me briefly recap the 3-3-5 rule that is meant to determine the affordability of the property you intend to buy.
Rule #1: 30% of property price
Your initial capital should at least be 30 percent of the property’s asking price, to pay for the down payment, transaction costs and other miscellaneous expenses.
Rule #2: 1/3 of monthly salary
Your monthly mortgage payment should not exceed one-third of your monthly salary.
Rule #3: 5 times of annual income
The purchase price of the property cannot exceed five times of your annual income.
The table below is a comparison between Dollars & Sense’s Affordability Table and my 3-3-5 rule.
As you can see, if you earn the “average salary per spouse” in Dollars & Sense’s table, you fail rule #2 (repayment less than one-third of monthly household income) in all types of private housing.If Dollars & Sense’s average housing price is accurate, prices of all categories of housing are higher than 5 times of annual household income which can’t pass rule #3.
Look before you leap and enter at your own risk
Compared with the Dollars & Sense Affordability Table, the 3-3-5 rule is no doubt more conservative and stringent in determining the affordability of a home buyer. After all, buying a home is usually the biggest purchase in a salaryman’s whole life. It’s better to be safe than sorry.
Of course, if I were a property agent or a developer, I would come up with a 1-2-10 rule. You will be relieved and happily hand me your cheque for the deposit.
Rather than complaining that the 3-3-5 rule is too strict and unrealistic, and that you will never be able to buy your dream home in this market, have you ever thought of the fundamental issues here?
If you need to pay more than one-third of your household income for your mortgage every month, you are not having enough buffer for a market downturn. If the housing price is higher than five times of your annual household income, you can’t really afford it. Either switch to a higher-paying job or settle for a more affordable housing type.
We are having the ‘boiling frog’ phenomenon here: When people are in a high-price environment for too long, they will gradually think that it is normal and acceptable to pay high prices. Similarly, when people are in a prolonged boom of the property market, they will forget what a ‘value-for-money’ home is, or why it is necessary to calculate the ROI of an investment property.
Affordability model for property investors
What about buying a private property for investment rather than for your own stay?Over the years, I have seen many investors being burnt by their wrong or untimely investment in the real estate market. So let me define affordability in four simple categories:
- Very Affordable
If the investment property is only one of your many investments, and any time you have to cut loss you don’t even bat an eyelid; if you can pay fully in cash or with a negligible loan, the property is “very affordable” to you.
- Highly Probable
If you can go through the 3-3-5 rule, and you have reliable streams of passive income not dependable on a pay cheque, your chance of riding out the storm is “highly probable”.
- Merely Stretchable
If you can’t pass the 3-3-5 test, and after you purchase the property, you must constantly worry about low rental, no tenant, interest rate hike, economic recession, job stability, failing business, etc., you are “merely stretchable”.
- Barely Reachable
If you have difficulty even forking out 20 percent for the deposit, and your property agent hints that “there’s a way to help”, you know that investing in a private property based on your current savings and financial situation is “barely reachable”.
Buying a property is different from buying stocks. It is more complicated and highly illiquid. Do you dare to take the plunge just based on your current salary?