Find a loan before a home, not other way round

IT IS easier to browse for houses online than it is to think about the debts that you will incur when buying a property.

Yet, unless you have S$2.4 billion in unmarked assets lying around, you will likely need to get a mortgage to pay for your house.

For a decision that can be as emotionally charged as buying a home, potential homebuyers should consider their budgets before house-hunting, said David Baey, chief executive of mortgage broker Mortgage Master.

“The awareness people should have is to find a loan before a home, not a home before a loan,” he said.

The first step for anyone buying a home should be to check their income and financial commitments against the mortgage-servicing and total debt-servicing ratios.

The mortgage-servicing ratio, capped at 30 per cent, means that borrowers cannot spend more than 30 per cent of their gross monthly income to repay their property loans.

This ratio applies to mortgages on all Housing and Development Board (HDB) flats as well as executive condominiums, of which the minimum occupation periods have not expired.

Meanwhile, the total debt-servicing ratio, capped at 55 per cent, refers to the portion of a borrower’s gross monthly income that goes towards repaying monthly debt obligations.

Borrowers buying an HDB flat through the Build-To-Order scheme or from the resale market may also need to choose between a loan from HDB and one from a financial institution.

Currently, interest rates have risen substantially because central banks around the world have raised rates to curb inflation. With a small and open economy, local interest rates have risen too.

As at Sep 28, the three-month compounded Singapore Overnight Rate Average (Sora), which is used as a benchmark by banks to price their loans, stands at 3.7071 per cent.

Meanwhile, the interest rate for an HDB loan, which is pegged to the Central Provident Fund Ordinary Account interest rate plus 0.1 per cent, is 2.6 per cent.

Home Loan Whiz senior mortgage adviser Wayne Quek said that borrowers buying flats now should opt for an HDB loan if they qualify for one.

He noted that an HDB loan will also allow you to borrow up to 80 per cent of the value of your house, versus 75 per cent with a bank loan.

Mortgage Master’s Baey also pointed out that borrowers have the option to refinance out of HDB loans into bank loans if interest rates fall later. Those who do so will incur legal fees of about S$1,600, as well as valuation fees of about S$200 to S$300.

Even so, banks typically offer some forms of cash or sign-up rewards when borrowers refinance with them. For instance, UOB offers a cash reward of S$2,200 if borrowers refinance a minimum loan amount of S$450,000 with it.

Homeowners and buyers considering bank loans will have to pick between fixed- and floating-rate packages.

Logically, fixed-rate packages should cost more than floating-rate ones because they offer borrowers a sense of certainty, for which banks will charge a premium.

However, banks have been charging lower rates for floating-rate packages than fixed ones.

For instance, OCBC offers a two-year fixed rate package at 3.75 per cent. In comparison, the lender’s floating rate stands at three-month compounded Sora plus 0.65 per cent for the first two years, which comes up to 4.36 per cent.

From this, Baey said, one could infer that banks expect interest rates to fall in the near term, and that sticking with an HDB loan or a shorter-term fixed-loan package would be the way to go for now.

“The banks want to lock in your fixed rate, and they believe interest rates will drop too,” he said.

Borrowers may also opt for shorter loan tenures, or a shorter amount of time over which to pay their loans to save on interest payments.

As an example, take the scenario of someone buying a S$600,000 four-room flat with a S$450,000 loan at an interest rate of 2.6 per cent.

If the borrower takes a 25-year loan, they will pay a monthly instalment of S$2,041.51 and a total of S$54,233.17 in interest over the first five years.

With a 20-year loan, they will instead pay a monthly instalment of S$2,406.55 and a total of S$52,772.77 in interest over the same period.

The total interest paid is lower because after each month, the lender recomputes the interest due based on the principal amount that is left. As the borrower with the 20-year loan pays off a higher amount of their principal to start, their interest costs fall as well.

Still, Quek recommends borrowers take up longer-tenure loans to have better cash-flow management.

“After the lock-in period of two to three years, you can always prepay the loan down if you have excess capital,” he said.

In contrast, Baey said that borrowers who see their financial situations improve should consider shortening their tenures as a form of fiscal discipline.

“(If) you have S$3,000 more in your bank account (each month), will you really save S$3,000 more... or would you actually spend a bit more, so you end up saving only S$2,000?” he said.

“You need to be more self-disciplined if you have greater cash flow every month, and we are all not as self-disciplined as we want to be.”

Unless, of course, you do have S$2.4 billion in unmarked assets and none of this matters. I would be very interested to understand how you manage your cash flow, then.