By Paul Ho (guest contributor)
In this article, we will look at how the Total Debt Servicing Ratio (TDSR) affects refinancing. According to MAS, if you were to refinance your loan with another bank or even just re-price with the same bank, you will still be required to pass the Total Debt Servicing Ratio (TDSR) requirement of less than 60%. All refinancing will have to pass the TDSR rule.
Why would people get hurt refinancing?
So who are the people who might be hurt? The many who bought their properties using a 35 year loan tenure or under a less strict Debt Servicing ratio of 60% (Note: A Debt Servicing Ratio of 60% is not the same as a Total Debt Servicing Ratio of 60%).
People who borrowed under interest-only financing would also be hurt when interest rates increase as they cannot switch. If they do switch, they will incur higher monthly servicing cost, and therefore could fail the TDSR threshold of <60%. Many financial institutions provided a “step-up” package home loan package, so these property owners are now stuck with increased financing costs and yet cannot refinance their home loan due to failing the new TDSR rule.
Case study of a 30 year loan refinancing
This individual got approved under a Debt Servicing Ratio (DSR) of 60% based on a lower interest rate set at 2%. The monthly installment works out to be $3,252 per month. This means that based on the DSR, this person is only at 36.14%. This calculation does not consider his car loan.
Figure 1: DSR of 60% using 2% interest rate to justify (Source: www.iCompareLoan.com)
He earns $9,000 a month and pays $3,255.65 a month on his installment, which is quite affordable. Even if the bank takes in his car loan of $1,500 a month for the Total Debt Servicing Ratio, he would still PASS at 55.70%.
But with the new rule, the TDSR must be assessed using an assumed interest rate of 3.5% and not the current actual interest rates of 1.5% to 2%.
Figure 2: TDSR at 3.5% (Source: www.iCompareloan.com Home Loan Report)
In this case, if we use 3.5% as the assessment interest rate, then this borrower will fail the TDSR requirement at 74.44%. This means that he cannot refinance away from his current loan to get savings. As he fails the TDSR, and the bank is starting to charge him higher interest rates, he is trapped.
Good intentions but unintended consequences
While the MAS means well to impose financial prudence amongst borrowers and financial institutions, this new law actually traps a group of property owners who now cannot refinance to cheaper rates and are trapped by the banks who first offered them these loans (perhaps imprudently). And we’re not even talking about extreme cases. By all measures, our hypothetical borrower earns a decent salary at $9,000 a month and is considered a high income earner.
So this rule which was meant to rein in aggressive lending by banks actually benefits the banks who initially lent more aggressively as they now have a group of home owners who cannot refinance and are trapped paying the higher rates charged by the bank.
Isn’t it ironic that the regulation ended up hurting those people who took the loan rather than imposing financial prudence on the aggressive financial institutions? This is like telling the naughty boy to behave, and that if he does you will give him a sweet. But as he knows he will be given a sweet even if he is bad, he may misbehave again to get another sweet – i.e. this is negative reinforcement.
By Paul Ho, holder of an MBA from a reputable university and editor of www.iCompareLoan.com, Singapore’s first Cloud-based Home Loan reporting platform used by Property agents, financial advisors as well as Mortgage brokers.