Is taking a "top-up" term loan common?

[chezball]

Hi Dennis,

I am thinking of getting a commercial or office unit, but do not wish to use cash for down payment. Since my current home is almost fully paid out, I am thinking of taking a "top-up term loan" (that is what the banks called it). Is it a common thing to do? are there any major pit falls?

1) the interest provided is the same as normal housing loan, which is about 2% (fixed) now. Which I think is reasonable.
2) But I can only loan 80% of current home price minus what I used from CPF. So if my home is 100K, and I used 40K from my cpf to pay for my home, I can only loan 80K-40K=40K. Why is this so? since if there is any default, the bank should have first take right?
3) At the end of the day I will be paying 2 sets of loans. So long as the monthly sum is <35% of total income, it should be ok right? or am I missing something?

[Dennis Ng]

Hi Dennis,

I am thinking of getting a commercial or office unit, but do not wish to use cash for down payment. Since my current home is almost fully paid out, I am thinking of taking a "top-up term loan" (that is what the banks called it). Is it a common thing to do? are there any major pit falls?

1) the interest provided is the same as normal housing loan, which is about 2% (fixed) now. Which I think is reasonable.
2) But I can only loan 80% of current home price minus what I used from CPF. So if my home is 100K, and I used 40K from my cpf to pay for my home, I can only loan 80K-40K=40K. Why is this so? since if there is any default, the bank should have first take right?
3) At the end of the day I will be paying 2 sets of loans. So long as the monthly sum is <35% of total income, it should be ok right? or am I missing something?

this is known as taking an Equity Loan or Cash Out Loan. It is very commonly done by Investors (the Rich), but something quite "alien" to the average person out there.

my answers are:
provided yours is a Private property (HDB flat cannot do this). Amount of loan that you can take needs to deduct CPF utlised for the property.

1. yes, same interest rate as Housing Loan in Singapore. In other countries, typically the interest rate is higher for Equity Loan.

2. yes, your calculation is correct. The "ranking" (repayment priority) in the event of sale of property is pay off Housing Loan first, next Refund CPF used, only if there is any excess amount then to repay Equity Loan, so equity loan is ranked after CPF, not before.

Your misconception is very common, most people have the same misconception.

3. yup. to play safe, you can also standby enough Cash/CPF to pay for 12 to 24 months of loan instalments in case you lose your job or suffer pay cut.

[chezball]

Hi Dennis,

Thanks for your response. Currently the property prices are near its peak, so it might be a good time to take up such (term) loan. But there is a risk when the market corrects. When that happens will the bank come back and do a re-valuation of your property and adjust the allowable loan?

For example if my home is valued at 100K now, max loan is 80K, contribution from my cpf is 40K, so I am allowed to loan 40K only. If the prices corrects to 70K, then my allowable loan will only be 16K! So will bank chase after the difference in cash (40-16=24K)? If, so how often do they do that? did this kind of thing happened in Singapore before (I know in US is has happened). Will the govt allow 30% drop of property prices? Cause this will impact a lot of residence since housing ownership is very top of govt agenda all along.

[Dennis Ng]

Hi Dennis,

Thanks for your response. Currently the property prices are near its peak, so it might be a good time to take up such (term) loan. But there is a risk when the market corrects. When that happens will the bank come back and do a re-valuation of your property and adjust the allowable loan?

For example if my home is valued at 100K now, max loan is 80K, contribution from my cpf is 40K, so I am allowed to loan 40K only. If the prices corrects to 70K, then my allowable loan will only be 16K! So will bank chase after the difference in cash (40-16=24K)? If, so how often do they do that? did this kind of thing happened in Singapore before (I know in US is has happened). Will the govt allow 30% drop of property prices? Cause this will impact a lot of residence since housing ownership is very top of govt agenda all along.

yes, it is a possible Risk that bank might ask borrowers to top up if Loan outstanding is higher than market value. How to mitigate this risk?

One simple way is to ensure that Housing Loan plus Additional Loan plus CPF used does not exceed 70% of market value.

When property prices fall, banks might ask those that borrow 80% to 90% to top up, unlikely to do that for those with 70% financing. Becos if they go after those with 70% financing, they practically have to go after more than 50% of their Loan customers...if borrowers can't top up the difference, it will be the Bank itself be in trouble.

I'm speaking from 17 years of Bank Lending experience, not theory. And I've been through the Asian crisis where property prices crashed by over 40%.

[chezball]

Hi Dennis,

Thanks for your feedback. Just to clarify about your guideline of not taking more then 70% of property value. Do you mean the 70% of the value at start of loan period? or 70% of the value that you think the property will drop to? Since the prices is "all time high" now, is there a need to take more buffer?

I would really like to hear what you think from your extensive experience. By the way, what happened post 1997 when prices dropped by 40%? Did the bank go after those who loan 60~70% of value during pre-crisis?

[Dennis Ng]

Hi Dennis,

Thanks for your feedback. Just to clarify about your guideline of not taking more then 70% of property value. Do you mean the 70% of the value at start of loan period? or 70% of the value that you think the property will drop to? Since the prices is "all time high" now, is there a need to take more buffer?

I would really like to hear what you think from your extensive experience. By the way, what happened post 1997 when prices dropped by 40%? Did the bank go after those who loan 60~70% of value during pre-crisis?

70% of the current market value. If you're afraid prices might crash, you can limit to say, 60% of current market value.

Nope. During Asian Crisis, banks went after those with 80% financing, not those with lower financing, provided the repayment is prompt and no delay.

So it is also important to standby enough Cash/CPF to pay for 12 months to 24 months of loan instalments to ensure one can pay the bank no matter what happens to the economy.

[chezball]

Hi Dennis,

Thanks for your insights!