By Mr. Propwise
It’s been less than six months since the Seventh Round of Property Cooling Measures and around four months since the hike in high-end property tax rates in Budget 2013, but the property market has not cooled. Developer sales, in particular, are still going strong while the resale market has been steadily recovering since March based on transaction volumes. Prices also stubbornly refuse to come down – the just-released URA flash 2nd Quarter 2013 quarter-on-quarter increase of 0.8% is an acceleration of 0.6% compared to the previous quarter.
So while it’s not officially a cooling measure, the introduction by the Monetary Authority of Singapore (MAS) of the Total Debt Servicing Ratio (TSDR) framework signals the Government’s continual concern about the exuberant state of the property market and its incremental (though so far mostly unsuccessful) efforts to cool it down.
Introducing the Total Debt Servicing Ratio
Effective 29 June 2013, the TSDR covers all property loans granted by financial institutions (FIs) to individuals (including sole proprietorships) and will require FIs to take into account all of the borrowers’ other loans when granting property loans. The TSDR will comprehensively cover all types of property loans, including those used to purchase property, those secured by property, and the re-financing of these loans (with some exceptions).
The TSDR is defined as:
Total monthly debt obligations / Gross monthly income
The MAS has set the TSDR threshold at 60%, with the potential of lowering it in the future, and considers any property loan made that is in excess of a 60% TDSR to be “imprudent”, and should only be done so in exceptional circumstances. The FI will have to jump through some hoops (e.g. get approval from its credit committee) to make property loans in excess of the 60% TSDR, which means that very few of such loans will be made. And while no specific punishments have been laid out for banks that breach these rules, most will not dare to.
Strict methodology to calculate the TSDR must be applied
There is also a strict methodology for calculating the TSDR. In particular FIs must:
1. Take into account the monthly repayment amounts for all (property and non-property) loans of the borrower. In the case of joint borrowers, the TSDR is computed based on the total monthly debt obligations and total gross monthly income of the borrowers.
2. Use the higher of a specified medium-term interest rate (set at 3.5% for housing loans and 4.5% for non-residential property loans) or the current market interest rate for property loans to calculate the TSDR
3. Take a discount of at least 30% on all variable income (e.g. bonuses and commission) and rental income
4. Take a discount on other financial assets that are used to assess the borrower’s debt servicing ability
5. FIs will also have to obtain and verify documentation used to compute the TSDR
The MAS hopes that the TSDR framework will encourage prudence both among borrowers and the banks making these loans, and to protect against reckless speculation on property and the potential fallout from a crashing of the property market. The stated “inspiration” for these rules was its discovery of “uneven practices” in banks credit underwriting practices, i.e. some banks were too aggressive when making loans.
Impact of the new TSDR framework on the property market
Simply put, the new TSDR framework will reduce the maximum loan quantum that most borrowers will be able to take, and in particular should affect the high end market and buyers looking for second properties the most.
I think most borrowers will fall into one or more of the following categories, and thus be affected:
1. Anyone with existing loans (e.g. car loans, unsecured credit etc) that some banks might have turned a blind eye to previously
2. Anyone who gets paid a bonus or has a variable component to his income (e.g. commissions). In particular, people working in certain sectors (e.g. Finance and Sales) where bonuses and/or commissions are a large proportion of total compensation will be affected to a greater extent.
And the rule on using a 3.5% mortgage rate to calculate the TSDR will affect everyone.
Let’s take a look at a hypothetical example – Mr. Tan, 30 years old, has a monthly income of $6,000, a car loan of $1,500 per month, and a bonus of $24,000 that year. Before the application of the TSDR, Mr. Tan could conceptually borrow up to $927 thousand with a monthly mortgage repayment of $3,200 (assuming a 1.5% interest rate, 30 year loan, 40% mortgage repayment to gross income including bonus).
With the new TSDR framework, his gross monthly income would now be modified to $6,000 + ($24,000 x 70%)/12 = $7,400 (versus the $8,000 previously). His maximum monthly mortgage payment would now be $4,440 minus the $1,500 car loan = $2,940. And don’t forget all FIs will now have to use a 3.5% interest rate to calculate the TSDR on residential property. Taking this into account, the maximum loan Mr. Tan can borrow will now drop to less than $660 thousand.
Thus assuming this is his first property and Mr. Tan wants to do an 80% LTV, the most expensive property he can buy post the implementation of the TSDR has dropped from around $1.16m to just over $800 thousand, or a drop of close to 30 percent.
Further tweaking of rules relating to LTV limits to close loopholes
The MAS has also tweaked the rules relating to the Loan-to-Value (LTV) limits on mortgages, in an effort to close loopholes that people have been using to circumvent these limits (e.g. parents guaranteeing loans for their kids to escape the Additional Buyers Stamp Duty), especially on their second and subsequent housing loans. “Gurantors” for loans will now have to be brought in as co-borrowers if the original borrowers fail the TDSR threshold.
Additionally, FIs have to use the income-weighted average age of borrowers when applying the rules on loan tenure for joint borrowers. This means that some joint buyers can no longer rely on using the combination of an older higher-income borrower and a younger lower-income borrower to get the “best of both worlds” combination of a large mortgage with a long tenor. For example, in the past joint borrowers who were 45 and 35 years old and earned $120,000 and $60,000 respectively could potentially still get a 30 year loan. Now with the new rules they would only qualify for a 23 year loan.
New rules are here to stay – fewer people can pay up for property
The MAS announcement even took pains to emphasize that these rules are “structural in nature”, which means that they are here to stay for the long term and will not be removed even if there is a correction in the market (unlike the LTV rules, which are flexible depending on market conditions).
The overall impact of these rules is that property buyers will be able to borrow less. In the past stretched home buyers, sometimes with the help of mortgage brokers, would “shop around” for more lenient banks to get bigger loans to buy property. While some of the bigger banks are already using a more conservative threshold for the TSDR (e.g. 40% to 50%), with the implementation of the TSDR framework, the strict rules now apply to all FIs.
Will the TSDR finally cause the property market to correct? Not necessarily, but the effective dollar value of property demand has been crimped, so when the day comes that forced sellers need to dump their properties, there will be fewer buyers able to transact on the other side, so a crash could be deeper and more painful than before.