Servicing home loans: Will your finances hold up?

Property fever seems to be heading back, as reflected also by the crowds flocking to property launches in recent months. Against this backdrop, are you planning to buy a property or upgrade your home? If so, first ask yourself three important questions, say financial planners and real-estate agents:

• Given your present budget, how much of a jump in monthly mortgage repayments can you tolerate, given that interest rates are expected to rise in the months and years ahead?
• Do you know how a slew of Central Provident Fund (CPF) changes which are being phased in will shrink your funds available for servicing a mortgage?
• As economic cycles get shorter, are you likely to be able to service your mortgage in the next downturn?Chances are, you have not considered these matters, say real estate agents and financial planners.

Says Mr Eric Cheng, a group director of PropNex, the largest realtor in Singapore: 'I tell you, most people stretch themselves to the maximum.'

Rising interest rates

Mr Cheng ventures: 'In years to come, the interest rate will surely go up to 4 per cent from the present 1.2 per cent for the first year of a mortgage. Home buyers should set aside a buffer.'

In the 1990s, interest rates ranged largely between 5 and 6 per cent - levels which would cause many home owners' present budgets to come under great strain. Banks are giving out loans based on repayments of up to 40 per cent of one's net income.

'That's a lot,' says Mr Cheng. 'If a couple is earning $5,000 gross a month, after deducting CPF contribution, car maintenance and mortgage, there's nothing left. What if the interest rate goes up to 4 per cent?'

'I think Singaporeans should set aside only 20 per cent of their net income for property.'

To get an idea of the impact of a higher interest rate, consider a loan of $500,000 with an interest rate of 1 per cent a year. The monthly repayment is $1,884. If the interest rate is 5 per cent, the repayment shoots up to $2,922.

Says Mr William Cai, a director of Frontier Wealth Management: 'Some of my clients' finances are not going to be able to take a sharp rise in interest rates. They won't be able to meet their other financial objectives such as saving for their children's education.'

A couple, for example, earning $9,000 in gross income now pays about $3,000 in mortgage instalment for a $800,000 loan through their CPF savings. If interest rates go up to 6 per cent, the instalment rises to $4,668. It would be tough for them to achieve their goal of retiring by age 60 with $5,000 a month to spend in retirement, calculates Mr Cai.

Not only are many home buyers failing to factor in a higher interest rate in their budget, they are also counting on two incomes to service the mortgage, notes Mr Cheng. He cites the example of a client whom he ended up advising against buying a landed property. 'The wife was working on a contract basis and it expired in two years time. I asked: What if the contract is not renewed?'

Limit on CPF withdrawal

Most home buyers are not familiar with a rule introduced in 2002 by the CPF Board which limits the amount of CPF savings they can withdraw to service their mortgage. Last year, the limit was calculated as 150 per cent of the property's valuation or purchase price, whichever is lower.

For properties bought from Jan 1 this year, the CPF limit has gone down to 144 per cent. The limit declines by 6 percentage points every year until it hits 120 per cent in 2008. Once you have used up the pre-determined amount of CPF, you have to pay your monthly mortgage instalment entirely with cash.

Consider a tough scenario: Assuming an average interest rate of 7 per cent and a property valued at $500,000 bought in 2008, the CPF limit would be reached within 17 years, calculates chartered financial consultant Leong Sze Hian. That is just a little beyond the mid-point of a typical 30-year loan. Imagine having to pay your monthly mortgage instalment entirely with cash for the remaining 13 years.

Many people upgrade or downgrade their homes along the way. The new CPF limit prevailing in that year will also affect them. 'In fact, every time you refinance your mortgage, that year's limit will apply to you too,' warns Mr Leong.

A study done two years ago on the CPF changes by the National University of Singapore's Department of Real Estate concluded: It is necessary to boost home buyers' awareness of the risks they face, and people have to downscale their property aspirations.

There are yet other CPF changes that you must take into account when deciding on your budget for buying a home. Ms Gan Poh Neo, an associate lecturer in financial planning at two local institutes, points out that the CPF contribution ceiling is being reduced from $6,000 to $4,500 by January 2006. In a nutshell, your employer will be contributing less every month to your CPF account.

Secondly, the percentage contribution to your CPF Ordinary Account has shrunk since last year and, for older workers, will shrink some more in the next two years.

Thirdly, the minimum sum - the amount of money you must set aside for retirement spending in the CPF account - is being increased every year by $4,000. This will affect the CPF savings available for monthly withdrawal for many people. So check with your bank or the CPF Board first on how much is available for withdrawal.

Says Ms Gan: 'The bottom line is that people must not budget their mortgage repayments down to the last dollar. A safety margin is needed.'