KEEPING A ROOF OVER YOUR HEAD
Your home may be the most expensive purchase you’ll ever make. Are you sure you can afford a long-term loan, come rain or shine?
Prepare for future expenses and unexpected events that could affect your home loan payments.
Even if you can afford your home loan now, you need to take into account unforeseen circumstances and future expenses that can affect your ability to make payments. Here are some things to look out for.
Loss of income
Just as you would put aside a few months’ worth of living expenses as emergency funds in case you lose your job, do the same for your property, says Alfred Chia, CEO of Singcapital, a financial advisory firm.
“Set aside three to six months of instalment payments in cash. This is a good short-term solution – a buffer that lets you continue repaying your loan while you look for another job.”
If you wish to be extra-prudent, you can maintain a year’s worth of instalment payments in your CPF Ordinary Account (OA) too, adds Desmond Chua, head of Loan Guru (part of the Property Guru Group), an online home mortgage consultancy.
Death, critical illness or sudden disability
This is where mortgage insurance comes in handy, says Alfred. “It’s an insurance plan especially designed to cover your home loan in the event of death, total and permanent disability or terminal illness.”
If you’re a private or condominium homeowner, this is a smart choice. Alfred advises signing up for it as soon as you purchase your property, as the premium will increase as you get older. “It’s one of the more affordable kinds of insurance and gives you peace of mind that you’ll always have a roof over your head.”
HDB homeowners are covered under the compulsory Home Protection Scheme, where the CPF Board will account for outstanding home loans should you become permanently disabled or die before the age of 65.
“If you wish to save up for your kids’ education and still meet your loan repayments, start an education endowment plan.”
Your kids’ education costs
If you wish to save for your kids’ education and still meet your loan repayments, a good way to ensure this is to start an education endowment plan – which will guarantee lump sum payouts after a specified number of years.
Alfred says: “It’s advisable to kick this off as early as possible, so that by the time your children are ready to attend university in 15 to 20 years, their education fees will be provided for. And you won’t need to worry about eating into your other funds.”
Fluctuating interest rates
Housing loans usually have two types of interest rates: Fixed and variable. Most homeowners go for fixed rate loans, where the interest rates are frozen for a specific period. The rate is usually pegged higher than variable rate loans – which means you could end up paying more during the lockin term when interest rates remain low and stable. But this will protect you against fluctuating interest rates, which could spike this year.
“If worldwide economic conditions continue to improve, we can expect interest rates to rise too. Based on previous records, our interest rates have risen up to four or five per cent,” says Alfred.
Protect your nest egg
You don’t want to have nothing left in your CPF for retirement by the time you’re done repaying your mortgage. That’s why there are valuation and withdrawal limits for CPF repayments – they ensure that you don’t overspend your savings when you finance your loan.
Alfred says: “When you use your CPF funds to service a home loan, there are two things to take note of: Valuation limit (the price at which you bought the property) and withdrawal limit (pegged at 120 per cent of the valuation limit). When you hit both limits in your loan repayments over time, you can no longer use your CPF to service future instalments.”
Are you counting on selling your property to fund your retirement? Alfred advises against this because
“A common pitfall when you use your CPF OA to buy a home is forgetting to set aside money to repay the accrued interest.”
you may be retiring when the property market is not buoyant enough to give you great returns. “If you retire when the property market hits a slump – like during the 2003 property bubble – you’d have to wait until the market revives, which can take years,” he says. You also need to prepare for the possibility that you won’t be able to sell off your property and downgrade when you retire, because your children may still need to live with you if they can’t afford a place of their own.
A common pitfall when using the CPF OA to buy a home is forgetting to set aside money to repay the accrued interest, says Desmond.
“Accrued interest – compounded yearly – is the amount you’d have earned if you hadn’t withdrawn CPF funds to pay for your home. CPF pays us a 2.5 per cent interest rate annually, based on the monthly amount withdrawn for your loan. Upon selling your property, you’ll need to return the principal plus accrued interest to your OA.”
Review your finances regularly
This is essential to staying financially healthy. “If interest rates fluctuate or if your spouse stops working, such changes can affect your Debt Servicing Ratio (DSR),” says Alfred.
Banks look at your DSR to see if you’re earning enough to cover your existing debts, before granting you a loan. But you can also use it as a way to see if you’re in good financial shape.
Here’s how to calculate your DSR: Divide your total monthly financial commitments – including credit card, car and insurance instalments – by your monthly income and multiply it by 100. If your DSR is below 40 per cent, you’re generally financially sound; anything above that means you need to review your finances.
Alfred explains: “For example, if you’re the sole breadwinner, taking home $5,000, a DSR of 40 per cent means you cannot use more than $2,000 for all outstanding loan repayments. If you’re paying $1,200 for your car and $300 for your credit cards, that leaves you with $500 to support your home loan, which may not be sufficient.”
Alfred recommends recalculating your DSR every two to three years or whenever your financial situation changes, so that you can look at options like repricing or refinancing your home loan if necessary.