How to Work Out Affordability in Property Purchase?

[Dennis Ng]

Below comments by Dennis Ng extracted from "The Dollars and Sense of Home Loans, an article published in Straits Times in Nov 2009.

Affordability issues

In order to ensure prudent financial planning, Mr Dennis Ng, spokesman for www.HousingLoanSG.com - a mortgage consultancy portal - suggests that home buyers track their total monthly debt repayment obligations.

These repayments should not exceed 35 per cent of their household income.

For example, suppose your car loan instalment is $800, other monthly bills are $1,200 and your housing loan instalment is $3,000. That adds up to a total monthly debt repayment of $5,000.

Assume a monthly household income of $10,000.

That means half your income is going into debts. In the language of financial experts, that is called a debt-servicing ratio of 50 per cent.

That is not advisable as it is well above the maximum recommended debt-servicing ratio of 35 per cent.

Another tip from Mr Ng is that prospective home buyers should not assess the affordability of a home they are eyeing by using current low interest rates.

Before the downturn in 2007, home loan interest rates were hovering at a higher rate of about 4 per cent.

So to be prudent, home buyers should calculate their instalments based on a higher interest rate of, say, 4 per cent instead. This would give them a better sense of whether they could afford the instalments if rates change.

Home buyers should set aside sufficient funds to meet future instalments should interest rates move up.

One's long-term repayment ability should take into account the stability of your source of income and the available Central Provident Fund (CPF) savings for the down payment and monthly loan servicing, said a spokesman for United Overseas Bank (UOB).

Consider a 25-year housing loan of $500,000 at a current rate of 2 per cent.

If indeed rates rise to 4 per cent, then monthly mortgage instalments will jump 24.5 per cent or about $520.

Using the same rate revision, if the loan is a higher $800,000, the hike in monthly instalments is about $830.

If the property is meant for investment and you are using the rental earned to fund your monthly loan instalments, you might want to factor in a possible drop in rental rates, added Mr Ng.

This is because rental rates fluctuate and it is only prudent to be prepared for the possibility of lower rental income to ensure you can still afford the instalments if rental rates fall.

Mr Ng advised home buyers to factor in a possible 10 to 20 per cent drop in rental.

Let's assume that the property is rented out at $3,000 a month. Rental falls of 10 and 20 per cent translate to lower rentals of $2,700 and $2,400, respectively.

Whether you are buying a house to live in or as an investment, it is prudent to have sufficient cash or CPF savings on standby to pay for at least six months of housing loan instalments in the event of unforeseen circumstances.

This means that if your loan instalment is $3,000, you should have $18,000 in cash and/or CPF monies set aside to cover six months of instalments.