“HIGH MORTGAGE” PLANS: A DOUBLE-EDGED SWORD?
At the time of print, HSBC had just raised the prime rate for the first time in a decade, from 5% to 5.125%. This was not a surprise but an official signal that we're at the end of a long cycle of cheap financing. Facing a new interest rate environment, should buyers choose high mortgage plans to secure properties?
The benefits of high mortgage plans allowing purchasers to borrow up to 80% of a property's value (or even 90% for properties under HK$4M) are obvious. A smaller down payment enables a larger purchase, and allows buyers to enter the market now instead of saving over many years. This is naturally attractive for many buyers.
Two main types of institutions offer high mortgage plans—banks and developers. Banks are strictly regulated and can only offer high loan-to-value mortgages on purchases of HK$6M or below, and the borrower must pass income stress tests to ensure they can bear the additional interest burden over time, even if rates increase in the future. If expected interest payments are deemed to be affordable relative to the borrower's income, then the application qualifies for mortgage insurance from the government-owned Hong Kong Mortgage Corporation.
Developers can offer financing plans on their first-hand sales without a stress test, including properties valued over HK$6M. Such loans typically use progressive interest rates that are low for the first few years (only slightly higher than bank rates), then increase to the Prime Rate (currently 5.125 to 5.375%) plus X%. Although this is significantly higher than banks' lending rates (roughly double), these plans have been very popular, leading to strong first-hand sales in recent years. Even knowing that the progressive rate will increase, and therefore also the all-in purchase cost, many buyers still choose to take this risk. Why?
Buyers often plan to refinance the developer loan with a bank loan in the future, before the progressive rate increases. Given the steady increase of property prices over the last decade, people may believe a 50% refinancing in the future may cover the 80% mortgage of today. While this has been a plausible strategy in the past, the market may not continue to rise. The key mainly lies in the stress test.
Refinancing with a bank loan hinges on passing the bank's stress test and qualifying for mortgage insurance and a higher LTV loan. If failed, the buyer must come up with the additional down payment (potentially 30% of the property value) to avoid high progressive rates. Otherwise, they cannot refinance and must begin paying the much higher interest cost.
Since developers don't conduct stress tests when granting loans, the best way to protect against this is to conduct your own. Will your future income safely cover a higher interest rate (3% or more)? Will you have liquid capital to cover an additional down payment, if needed, especially if property values fall? If you cannot refinance, will you be able to cover the progressive rate on the developer loan? When considering a high mortgage loan, carefully consider these questions to be sure of your financial position throughout the loan period.