STI: Stretching your home loan just doesn't pay

Apr 6, 2004

Stretching your home loan just doesn't pay
by Leong Chan Teik

WHEN you are 20- or 30-something, it's hard to imagine being 60-something.

You can't be sure of your health, wealth and employment over the decades leading to that point in time.

But banks will let you borrow a big sum of money to be repaid in monthly instalments until you are 60-something.

OCBC Bank, for example, will lend you money for up to 40 years to pay off your HDB flat.

At DBS Bank, you can stretch your mortgage till you turn 70 - or over a period of 35 years, whichever is earlier.

All this is a far cry from when home loans usually ranged between 10 years and 20 years back in the 1980s.

Surging property prices, among other changes, have since created a consumer demand for longer mortgages, and banks have responded.

Whatever your age is, long repayment periods coupled with the current low, low interest rates can seduce you into taking up a big home loan you may be better off not having.

Mr Choy Kum Yuen, 46, tells of his amazement when a 20-something friend recently mentioned she had just saddled herself with a 35-year home loan.

This was for a condominium unit whose downpayment her parents had helped her with.

The duration of her loan contrasts sharply with the 15-year one which Mr Choy, a vice-president in a transport company, took in 1992 when he bought his present home, a private apartment.

'I remember my main consideration then was to pay off the loan by the time I reached my 40s,' he says. 'The idea was to save over the next 10 years or so for retirement.'

Mr Choy and his wife paid off their last instalment in December 2002. That was nearly five years ahead of schedule, because along the way they accumulated extra savings and regularly channelled part of that to repay the loan in addition to the monthly instalments.

'After the last instalment, in celebration, we went to South Korea for a skiing holiday,' remembers Mrs Darrell Choy, a senior executive in a financial institution.

'It sure feels liberating not to have a housing loan over our heads anymore,' she adds.

The Choys have not calculated it but there were significant savings in interest payments from their shortened mortgage.

Associate Professor Benedict Koh, who teaches personal finance at the Singapore Management University, worked out an example.

Suppose you took up a 35-year monthly-rest housing loan of $600,000. (Monthly-rest refers to the basis of calculating interest on a loan, where the principal is reduced every month.)

The interest you would have paid after 35 years adds up to $671,813, based on a long-term average interest rate of 5 per cent. Note that the total interest payment is higher than the loan you took.

If the loan period was 20 years instead, you pay total interest of only $350,336.

That is a significant reduction of $321,477.

'I often joke with my students that many Singaporeans are potential millionaires. But they don't become one because they hand most of their money to the bank,' says Prof Koh.

There is no magic number in response to the question of how long an ideal housing loan is.

As a general principle, do not use more than 40 per cent of your monthly disposable income for servicing of all types of loans, says Prof Koh.

This includes mortgage payments, instalments for renovation loans and car loans as well as credit card payments.

Also, consider making partial repayments of the loan principal whenever you have surplus savings, he says.

When you do so on a loan with a 5 per cent interest rate, that is equivalent to earning a guaranteed investment return of 5 per cent on your money, he says.

Mr B.J. Ooi, director of KPMG Tax Services and head of KPMG's personal financial services unit, says: 'Most of my clients try to pay off their housing loans early. And they are savvy people.'

If the interest rate on your housing loan is as low as 1.5 per cent, you would not find it as attractive to repay your principal, he says.

But for many people, the rates are higher.

Real estate agent Raymond Ho, a senior associate director of HSR International Realtors, offers some reasons a long mortgage can be attractive and beneficial, especially to first-time home owners.

By opting for a long loan, young people - or anyone else for that matter - can get to buy their dream home earlier, he says.

They don't have to cough up a lot of cash every month to service the loan.

And they can depend on their Central Provident Fund savings to service a big chunk, if not all, of the monthly mortgage.

But Prof Koh asks: Why not settle for a more 'humble' dwelling which you can buy with a reduced loan tenure?

Instead of a fancy condominium unit, why not an HDB flat? Or have you raised your expectations so high that only, say, a Pasadena condominium (at Novena) or Water Place (East Coast) will do as a first home?

Tough economic times that you may run into along the way can make you regret you over-committed to a housing loan.

Mr Choy says: 'I know of at least two persons who wished they had finished off paying their housing loans, given the uncertain economic times, shortening employability and high costs of living.'

If you stretch the loan period to the maximum, you have little breathing space, moneywise, when interest rates rise from their present record low.

The spectre of your house being repossessed by the bank will haunt you.

Prof Koh says: 'Making a housing loan decision based on current interest rates is myopic. It is also clearly a case of poor financial planning.'

Just about every expert says that there is no way that interest rates will stay where they are now for very long.

And that's a far greater certainty than what your financial circumstances might be when you approach 60-something.

Set aside money for other pleasures

THE Choys believe that if you don't over-commit your finances to a home, you will have room for other meaningful pleasures in life.

For them, one of these pleasures is a family holiday every year to places such as Australia, South Korea and Japan.

'We can't enjoy these holidays if we commit every cent to our home. That would be depressing,' says Mr Choy Kum Yuen, 46, a vice-president of a transport company.

There are other big goals too, such as ensuring that their retirement nest egg and their children's tertiary education are well taken care of.

To achieve the goals faster, Mr Choy has invested some money in stocks that pay good dividends, such as Singapore Post.

Having paid off the loan on his home in December 2002, he has more money for investing.

He and his wife bought their 1,335-sq-ft freehold apartment in Balestier, which has three bedrooms, for about $455,000 after their first child, Jessica, was born in 1991.

They subsequently had a son, Nigel, who is now 10.

'A happy home is not about how big or opulent the house is but about the people living in it,' says Mrs Darrell Choy, a senior executive in a financial institution.

And as the plunge in property prices over the past seven years has shown, a home is not an investment you can count on to fund your retirement.

Says Mr Choy: 'The myth of ever increasing property prices has been shattered, so don't think that you can downgrade your property to 'free up' its value when it's time to retire.'