Sunday, October 07, 2007

Personal Finance Part 3 – Property & Housing

Ok, first things first, I need to make a disclaimer: I am not an expert at property and am just a passive reader of news bits involving the current property cycle. My observations are purely from the perspective of a layman as I do not fully comprehend many aspects of the property market. The property boom is Singapore now is reminiscent of what happened back in 1994-1995 when prices were rising as well. Since value investing does not really incorporate real estate in its philosophy, I will attempt to discuss properties and housing more from a personal perspective.

I will concentrate my discussion more on HDB flats, as I own one myself. The broader aspects of financing and mortgage loan repayments is also applicable to other types of properties like freehold condominiums as well as landed property. Firstly, when one purchases a HDB flat, HDB will “wipe out” your entire OA balance as part of the down-payment for the flat. You can prevent the full wipe-out by channeling some of your funds into CPF-approved investments like unit trusts or equities; should you wish to retain some balance for future tiding over. This is something which many have to be wary about, because the sudden loss of your job or income generating ability (touch wood !) could hit one hard when the OA balance is swept clean.As for loan interest rates, HDB is granting a concessionary interest rate of 2.6% per annum, which is 0.1% above the prevailing interest rate on the OA. This has been kept constant ever since I obtained my flat in Jan 2004 and I hope they keep it that way for a long time to come ! It’s one of the cheapest loans you can get in Singapore, so for people who wish to opt out of the HDB loan and obtain a bank loan instead (for the lower first 2 years interest), please note that there is no way to “opt-back” into the HDB loan scheme (i.e. you are excluded forever !). Most local banks offer rates of up to 2-2.5% for the first two years, after which a floating interest rate applies which can go to as high as 4-4.5%.

The question of choosing one’s loan period is one of great importance. If you are just starting out to work and not earning a high salary, it would be advisable to take on a slightly longer loan (up to 25 years perhaps) to obtain a lower mortgage monthly payment. As you and your spouse’s salaries and income increase, the monthly repayment can be gradually increased in order to reduce the total loan period. I have found this to be a good method of reducing the loan period in a gradual manner, while saving on interest in future periods as well. Increasing the loan repayment amounts is much preferable to doing a lump sum repayment (on getting your bonus, for example). This can be shown using a loan amortization table (similar to a finance lease amortization table for those of you accounting-trained readers). This is illustrated as follows:-

Assuming a loan of S$250,000 with HDB concessionary rate of 2.6%. The husband and wife are both contributing S$500 each (S$1,000 in total) from their OA towards repayment of the monthly installment. Column A will represent the monthly interest on the principle (column D). Column B represents the repayment amount per month while column C is the net effect of the interest charged versus the repayment amount. Column D in the respective month will then show the new reduced principle amount of the loan for future periods, carried forward. I have only shown a sample of this table which can easily be produced using an MS Excel spreadsheet. If we extrapolate forward, it can be seen that this loan will only be fully repaid by July 2043 (which implies a total loan period of 36 years). Of course, this example is just illustrative as HDB only grants maximum of 30-year loans; but the idea is tweak the numbers to obtain the desired results. Just by changing the gal’s and guy’s contribution to S$1,000 each (S$2,000) in total, the loan period is drastically reduced to just 14 years (loan ending in October 2021).

One final point to note is to ensure you have sufficient balance in your OA to tide you over at least 6 months of installment payment (in case you are out of a job, for example). This means that bonuses (which increase your OA quickly as the full amount of CPF is credited to your OA, not limited to just 23% of S$4,500 per month).should be retained in order to tide one over for a rainy day, rather than being used as lump sum repayment. This is just a personal opinion though, one should tweak the spreadsheet according to his or her financial condition.

For more information on housing loan assistance, I would strongly recommend Mr. Dennis Ng of Leverage Holdings Pte Ltd. He has been giving financial advice and tips on Wallstraits forum for the past 5 years and has also been invited to write articles in BT and give talks on property loans. His website can be accessed here.


fishman said...

Hi Musicwhiz,

Thanks for the leg-up! I've just drew up my own home loan amortization based on the template you've shown. Think it'll certainly be very useful down the road!

I think I'll probably not increase payment along the way, even when and if our pay increase. Instead I'll invest the additional monies, since interest is low. Just some thought lah!~

Hope you don't mind a question - How do you value REITs? Any different to valuing of other company entities? Thanks!


musicwhiz said...

Hi fishman,

Glad my template proved of use to you. Mine is just a very basic discussion on property and HDB as Dennis is the expert on such matters. It's a good idea to invest additional CPF monies assuming u can get a better than 2.5% per annum return. If not, then you are better off repaying more of the loan. Another factor to consider is that repaying the loan faster also means you have less to worry about should anything happen to your job (again, touch wood !) as your interest charges would have been reduced due to the higher repayment. Ultimately, my aim is to be debt free by 40 and I hope I can achieve that. :)

REITS are usually valued based on their NAV (and not PER). PER for REITS can be very high at 35-40x, thus it is not a good measure. Another thing you can look at for REITS are their acquisition policies, gearing and also dividend yield.

Hope this helps !

Regards, Musicwhiz

Anonymous said...

Hi musicwhiz,
I'm impressed! You really cover multiple aspect of financial planning.

Will you be doing a writeup on buying property as an investment in Singapore? Singaporeans love this form of investment.

Do you know the details eg how much of our CPF we can use for a second property? What are the estimated returns over 10 years vs shares? Which are the best rental yield areas in Singapore etc?

musicwhiz said...

Hi Anonymous,

Thanks, I try to give an overview of other ways of building personal wealth, but value investing in terms of shares is still my strength.

I will not be doing a detailed write-up on property as my blog is more geared towards value investment in shares (and not properties). However, I may in future do another posting on properties once I learn enough about them, as I would not want to mislead anyone with errorneous information. Singaporeans love this form of investment, but many have got burnt as well because they tried to "flip" too much.

For your questions, I would suggest asking Mr. Dennis Ng who is an expert on giving advice on property matters. I am not qualified or knowledgeable enough to give any advice or opinion.

P.S. - BT did have a pullout on property some weeks back which is very useful for the layman. Hope you managed to catch that !

Regards, musicwhiz

Anonymous said...

Thanks :0).
Looking f/w to your next postings.

musicwhiz said...

No problem. Have a great day !

Regards, musicwhiz