Finance experts love to use special words to describe rather simple concepts. This is because jargons help specialists to communicate more efficiently, while also making them sound much more sophisticated and complex. When it comes to financial jargon, one of the most perplexing ones might be those concerning home loans. Especially if you aren't from a financial background, it can be rather difficult to remember all these jargon and complicated ratios. However, given that home ownership exceeds 90% in Singapore, you will have to deal with these words at least once in your life. Since purchasing a home is one of the biggest financial decisions you will ever make, it will be helpful to know some of the more important concepts that we feature below to ensure you know what you are signing up for and what you are able to get.
1. Loan-to-value Ratio
Loan-to-value ratio, or LTV, refers to the ratio of the loan amount against the value of the property. For instance, if the property is worth S$800,000 and you took out at mortgage loan of $560,000, your LTV is 70%.
In Singapore, most banks offer mortgage loans up to a maximum of 80% LTV, while HDB loans can get you up to 90%. The amount the bank can lend you also depends on other factors, such as whether you are currently holding other mortgage loans or the loan tenure. Generally, longer loan tenures and having another home loan will decrease the amount you will be able to borrow due to higher default risk.
Generally, you want to find a balance between maximising your LTV while keeping your risk manageable. A high LTV ratio allows you to put up the least amount of of capital out of your pocket to purchase your home. This also helps accelerate your gains when the value of your home increases. For instance, in our previous scenario, if the value of your property increases by 25% to S$1,000,000, your equity in your home would increase by 83% from S$240,000 to S$440,000.
However, you must be careful to when trying to maximise your LTV ratio. Just as a high LTV juices your return when property price goes up, it will just the same way when the value of your property declines. For instance, a 25% drop from S$800,000 to S$600,000 could wipe out almost all of your equity in your home. Not only that, borrowing too much could expose you to interest rate risk: while your monthly interest payment may be manageable when rates are low, it could no longer be manageable when rates increase (like they are doing today). Therefore, you want to leave a sufficient margin of safety in both equity value and interest payment by not going overboard with getting a home loan.
2. Total Debt Servicing Ratio
In order to help consumers manage the second risk of interest payment that we mentioned above, the Singaporean government has introduced a concept called Total Debt Servicing Ratio. To put it simply, Total Debt Servicing Ratio(TDSR) is an affordability ratio that is meant to prevent borrowers from being over-extended. In Singapore, the Monetary Authority of Singapore(MAS) introduced the TDSR framework in 2013 as part of the property cooling measures to curb property speculation.
The TDSR framework limits the amount of one has to pay in interest to his borrowers to 60% of one's gross monthly income minus all of the existing debts. These existing debts include other mortgages, credit cards, personal loans, auto loans and so on.
For example, if you earn a salary of S$8,000 a month, then your TDSR threshold is S$4,800 (60% of S$8,000). If the total monthly repayment for of all your credit card, car loan and personal debt is S$2,000, it means that the maximum monthly repayment for your home loan cannot exceed S$2,800 (S$4,800-S$2,000).
When applied to mortgage loans, the term haircut is used as a kind of buffer calculation on a borrower's salary to reduce the risk of default. A haircut is typically used if the borrower earns a variable income, which includes sales commission, side income from freelance work or even rental income.
For people with variable income, their income level faces a 30% haircut, meaning 70% of their monthly income applies to their TDSR ratios. If your total annual income was S$96,000(average S$8,000 a month) because of a special year-end bonus of $S10,000, you would have earned an average of around S$7,166.
But because of the haircut, the income that qualifies for borrowing will be 70% of S$96,000, which equals to S$5,600 a month. That's S$1,566 less per month that's taken into consideration. The implication of this is that it can limit the type of property you can buy since the amount of loan you can afford is now smaller.
4. Additional Buyer Stamp Duty
You might be familiar with buyer stamp duty(BSD) - a document executed for the sale and purchase of property located in Singapore. BSD for property in Singapore is at 1% for the first S$180,000, 2% for the next S$180,000 and 3% for the remaining amount. With the high average price of property here, it is safe to say that you need to put aside about 5% of the property's price for stamp duty.
One of the cooling measures introduced in the last few years was the Additional Buyer's Stamp Duty (ABSD). Basically, Singaporeans buying a second residential property will now have to pay an extra 7% of ABSD, and another 10% on their third properties. For Singapore Permanent Residents, they will pay an extra 5% ABSD on their first residential property, and 10% on their subsequent properties. For foreigners buying any residential property in Singapore, they will pay an extra 15% in ABSD.
5. Mortgage servicing ratio
Now that you've read about the TDSR, there's another term that is quite similar called the Mortgage servicing ratio, or MSR. Unlike the TDSR which applies to all mortgage loans, the MSR applies only to loans for HDB flats and Executive Condominiums (ECs).
The MSR caps the amount that a borrower can spend on mortgage repayments to 30 percent of his gross monthly income. While the theory is straight forward, it can create some problems for borrowers due to the following:
• banks use a 3% interest rate to calculate the loan repayments although most home loan rates are lower than 3% • variable income will take a 30% haircut • financial assets must be pledged with the bank for four years, and • the maximum loan tenure is 25 years for HDBs and 30 years for ECs
6. Board Rate
You might already have heard of the SIBOR and SOR used as benchmark interest rates to calculate your mortgage loan interest. But what's board rate? Board Rate means your home loan interest fluctuates based on the bank’s internal decisions. Some borrowers do not like taking loans with board rates because they deem it less transparent.
7. Prepayment Penalty
You might have thought that the bank would be happy for you to repay as much of the loan as you can when you have the cash on hand. However, banks take into consideration the interest they will earn from you, so repaying them early means they lose out on the interest profit. This is why most home loans come with a prepayment penalty if you choose to repay part or the full amount of loan before the tenure ends.
Some banks attract potential home loan borrowers with a one-time free “conversion” term in their mortgage loan. Conversion refers to the act of transferring your existing loan package to another within the same bank. This can be useful in helping you reduce your borrowing costs if current interest rates terms are more attractive than the one you had signed up for previously.
Home loan documents can be littered with jargon and terms you may not be familiar with. It's always good to consult with a mortgage broker who is able to recommend a suitable home loan or visit a comparison site to ensure you've got the best home loan interest rates available.