Buying a property, whether for own stay or investment, involves a large sum of money. Most people will loan a great proportion of the purchase price, while paying just the minimum required for the down payment.
As “cash is king”, majority prefer to hold spare cash for contingency and, therefore, borrow as much as it is allowed by the bank - according to the borrower’s credential especially when interest is low.
Hence, it is essential for property owners to know what it entails in getting a housing loan and the intricacies of refinancing or repricing a home loan.
In-Principal-Approval from Bank
When we have an intention to buy a property, it is advisable to obtain an in-principal approval (IPA) from a bank before embarking on our property search. An IPA is an estimate given by bank to prospective buyers before finalising any property or to existing property owners before deciding on a refinancing.
The home loan will not take place when you seek for an IPA. It provides an estimate on the eligible amount to loan and is valid for 30 to 90 days.
IPA will help to:
Focus our property search on those that falls within our limits.
Reduce time and effort in property hunt.
Enhance our negotiation power with the seller
Facilitate the actual loan application.
Better plan our financing for the purchase
In getting an IPA, buyer will need to submit relevant documents required by the mortgage bank for assessment.
Bank Assessment on Loan Amount
The bank will compute the total debt servicing ratio (TDSR) or prevailing mortgage servicing ratio (MSR) to determine the eligible loan amount.
Besides TDSR and MSR, the bank will also evaluate the financial health and credit history of the borrower before granting the approval.
How is TDSR calculated?
TDSR refers to the portion of a borrower’s gross monthly income that goes towards repaying the monthly debt obligations, including the loan being applied for.
The allowable TDSR currently stands at 60%, which means that monthly total debt repayments must not be more than 60% of the monthly gross income. The formula is as follows:
Total Debt Servicing Ratio = (Borrower's Total Monthly Debt Obligations / Borrower's Gross Monthly Income) x 100%
The Borrower's Total Monthly Debt Obligations consist of all property loans (including the loan being applied for and loans which we are a guarantor), non-property related loans such as car loans, renovation loans, student loans, and credit card bills.
The Borrower's Gross Monthly Income refers to our monthly income before tax and excludes any CPF contribution made by the employer.
The average monthly variable income (e.g. commission, bonus and allowance) and rentals in the preceding 12 months are subjected to a minimum amount of 30% reduction (haircut) by the bank.
Example
Sam is an employee with monthly gross salary is $10,000, monthly repayment of car loan is $800, and his two children’s study loans are $1500.
Current allowable TDSR = 60%
Allowable Total Monthly Debt Obligations = 60% x $10,000 = $6,000
Current Monthly Debt Obligations = $800 + $1,500 = $2,300
Additional monthly debt (loan) allowable = $6,000 - $2,300 = $3,700
Hence, Sam can take a loan with monthly mortgage repayments up to $3,700.
If Sam takes a loan of 25 years tenure at an interest rate of 1.7% p.a., he should be able to loan about $900k, which translate to the authorised maximum loan of 75% property price.
Therefore, plus another 25% mandatory minimum down payment ($300k) from cash or CPF savings, Sam can buy a property of $1.2 mil.
Apart from satisfying the TDSR limit, HDB buyers will also have to satisfy the MSR cap.
How is MSR calculated?
The Mortgage Servicing Ratio refers to the portion of a Borrower’s Gross Monthly Income that goes towards repaying all property loans, including the loan being applied for.
The current MSR is capped at 30% of a borrower's gross monthly income.
MSR cap applies only to housing loans for the purchase of an HDB flat or an executive condominium bought directly from a developer.
The formula is:
Mortgage Servicing Ratio = (Housing Loans / Gross Monthly Income) x 100%
As MSR cap is set at a more stringent level, those that satisfy MSR criteria will most likely meet the TDSR requirement.
For more information on TDSR and MSR, click on the link:
Interest Rate
Naturally, we approach the bank that offers the most attractive home loan interest rate at that time to get the IPA.
There is no obligation to follow-up with a loan application from the same bank if we subsequently find it no longer offers us the best rate during the loan application.
There are two categories of interest rates for home loan:
Fixed
Floating (variable)
In most cases, Fixed Rates are higher than Floating Rates as banks take on the risk for the changes in market conditions.
Usually, banks offer Fixed Rate for the first few years and subsequently will be revised to a Floating Rate, as predetermined in the loan package.
Opting for the Fixed Rate allow us to plan for our finances and set aside a constant amount for the monthly loan mortgage repayment.
However, in Fixed Rate scenario, most banks do not allow flexibility for partial or full redemption and the loan amount will thus be locked-in for a period as stated in the contract.
Nevertheless, some banks do allow penalty wavier if redemption is due to sale of the property.
As the interest of Floating Rate is lower, many borrowers are allured to take it up.
The table below briefly describe the different types of mortgage rates:
If our property is for investment purpose, remember to keep records of the total interest paid annually to claim relieve from our rental income during income tax submission.
Repayments
The repayments are done in monthly installments and the amount depends on the loan tenure, loan size, interest rate and method of interest computation (which is commonly based on monthly rest).
The loan repayment schedule (also known as the amortisation table) will be given by the bank or shown in bank website. It will show clearly what portion of your monthly installments goes to your Principal repayment and how much into paying for the interests.
We can use the repayment schedule as a comparison to decide on which loan package to go for, focusing on the total amount of interest payable, especially during the few initial years of the loan lock-in period.
Prepayment
Prepayment is to repay our housing loan (in full or partially) before the completion of our loan tenure, especially if we have additional funds. It will reduce the outstanding principal amount, which consequently reduces the Equated Monthly Instalments (EMI) or the remaining loan tenure.
Depending on our comfort level, after a while, we may want to adjust our loan to reduce the interest payable, by cutting down the loan tenor, pay higher monthly repayment installments or lower the loan quantum by clearing part of it.
However, we should also consider if it would be more beneficial to invest the additional funds or to prepay the loan to save on the total interest payable, it would very much depends on which option provides better returns, notwithstanding the prepayment charges applicable.
Before we decide to commit to prepayment, it is important to check with our bank on the prepayment fees or penalties applicable. Most banks charge a certain percentage (about 1.5%) on the repayment amount during the lock-in period.
After the lock-in period, it requires one to three months advance notice before the intended prepayment date, in lieu will be the interest payable. There is also a breakage fee of about 0.5% if the prepayment date is not on the expiry date of an Interest Period.
Therefore, find out what are the charges incurred, if there is any penalty imposed, the minimum period of notice and the minimum repayment sum. These are usually written in the loan agreements, but often being overlooked.
Repricing vs Refinancing
Repricing is switching our home loan within the same bank to a more attractive package, while refinancing is switching our home loan for another package with a different bank.
Some banks offer a one-time repricing as part of the packages so we can move between the existing loan packages without incurring costs.
There is usually a onetime administration fee of a few hundred dollars for repricing, while some banks may waive the fee. Repricing our home loan within the same bank is cheaper than refinancing with another bank when it comes to incurring fees.
We should reprice or refinance only if we get to enjoy savings or opt for for a loan package which better suits our needs.
Here are some points to consider before we decide to reprice or refinance our home loan. The costs include:
Repricing
Administrative Fee from existing bank ($300 - $800). ·
Refinancing
Prepayment Penalty from existing bank in lieu of 2-3 months advance notice (1%-2% of redemption amount).
Valuation Fee ($500).
Legal Fee (depends on property purchase price; from $2500),
The fees incurred for repricing or refinancing our home loan is another aspect to be considered carefully. As a general guide, it will not be worth if the costs of change are more than the interest savings we gained in a year.
However, changing of loan package to a better deal is encouraged as some banks are willing to waive/ absorb the costs if we meet the required minimum loan size.
Notwithstanding, it may not be worth to pay the extra penalty of 1.5% of undisbursed loan imposed by most banks for breaking lock-in clause.
Other aspects to note for refinancing are that there is usually a minimum loan sum imposed, and we may not be able to get the loan amount financed by another bank if there is a drop in our incomes or there is a change in our TDSR due to recent commitments.
Repricing and refinancing are different, however, there are circumstances when one works better or is more suitable than the other.
Whether we choose to reprice or refinance our home loan, we need to consider the costs and savings or making the switch.
Insurance
Most banks will require the borrower to take up a fire insurance for the mortgaged property or a Mortgagee’s Interest Policy (MIP). MIP is necessary for buyers who only need to put down less than 20% of down payment for the property purchase, such as HDB flats.
It mitigates the risk of the lender in offering this amount of loan. This is prevalent to HDB flat buyers. However, the borrower can opt out from MIP once the loan has been repaid for more than 20%.
Default
A loan default occurs when we do not pay the repayment on schedule.
However, the bank will generally start following up on a late payment when it is about 7 days overdue. Late fees and interest charges will apply if payment is not received during the grace period.
And after 30 to 90 days without payment, depending on the bank, the mortgage is considered as default.
In a default of monthly repayment installments, the bank can:
Declare “an event of default” and recall the loan.
Charge a higher rate of interest.
Sue the borrower for the outstanding housing loan.
Initiate foreclosure to sell the mortgaged property to recover the outstanding loan amount and unpaid interest.
Sue the borrower for any remaining sums unpaid if the sales proceeds from the property is insufficient to pay off the outstanding loan.
Bring bankruptcy proceedings against the borrower.
In order to prevent a default situation, we should:
Not commit to a loan package that we cannot afford.
Contact our banker or financial advisor immediately to discuss ways to mitigate the repayments once we face an unforeseen financial situation, like sudden loss of income, to meet the monthly repayment.
Summary
When taking a home loan, our properties are pledged to the lender as collateral for the loan. Amount granted for the loan is based on eligibility of the borrower. The loan is disbursed to the seller after down payment is made. Interest is charged from the first disbursement.
Home loan is usually a Term Loan which has a fixed loan tenure with either fixed or variable interest rate. It has a fixed installment repayment schedule and cannot be recalled by the bank, unless there is a default.
If the value of the pledged property falls below the loan amount, the borrower may have to top up with more assets or pay down some of the outstanding loan amount.
If the loan is not repaid or defaulted, the property can be repossessed by the bank and sold to recover the loan amount and unpaid interest.
It is necessary to check the packages offered by the banks, including the types of interest rate and its fine details. Screen through the prepayment charges contained in the loan agreement paper carefully to make sure it is in line with general prepayment rules, market practice and what have been briefed by the bankers. These charges may eventually deters us from refinancing the loan with another bank if the existing bank charges higher than market rates.
Importantly, get an IPA before committing to a property.
If need help, call me @ +65 94742623 for a non-obligatory discussion and advice.
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I am a Real Estate professional with proven records and 10 years’ experience in helping clients to acquire their dream homes and fulfilling their property investment goals.
Skilled in facilitating purchase, sale and leasing of commercial, industrial, private residential and HDB properties, I enjoy my interactions with clients and find joys and sense of fulfillment whenever they found the properties that met their needs or when they benefited from their investments in the properties that I had helped them purchase.