Friday 17 August 2012

To take or not to take a 50-year home loan

By Esther Teo, The Straits Times, 16 Aug 2012

UNITED Overseas Bank's (UOB) recent introduction of 50-year housing loans has sparked a debate over whether it will lead to borrowers overextending themselves financially.

National Development Minister Khaw Boon Wan weighed in last week on the loan packages - likely the longest-duration loan in Singapore. He called it a "gimmick" and advised home buyers not to fall for it.

Mr Khaw's concern is a valid one. Taking up a 50-year loan, instead of the usual 30-year one, allows a buyer to pay a smaller monthly loan instalment.

If a borrower takes out a 50-year loan for $800,000 at a flat annual interest rate of 2.5 per cent, he would have to pay about $2,337 monthly for his mortgage, compared with $3,161 if the loan ran for 30 years, according to mortgage comparison website

The result is that buyers may be tempted to buy a more expensive home than they can really afford, overstretching themselves financially in the process. Meanwhile, the longer repayment period means that a lot more interest is paid over the life of the loan. A borrower taking up a 50-year loan on the terms above would pay $264,000 more in interest than if he had opted for a 30-year loan.

But is the issue necessarily so simple?

Mr Khaw's disapproval is based partly on an assumption that the home buyer services the loan throughout the 50 years of the loan, and therefore incurs a punishing interest payment.

In reality, however, not many borrowers end up doing that. Industry players estimate that more than half of borrowers pay off their home loan before the full term is up.

Some do so when they upgrade to a new property; others make capital repayments midway. Many also refinance their loans after a few years.

Seen in this light, a 50-year loan is a temporary "evil" that young couples and executives put up with as they try to get on the first rung of the property ladder in an era of rising property prices.

Later, as circumstances improve - when incomes go up with career advancements - they can refinance the loan and go for the more traditional 30-year option that incurs less in interest payments.

The problem with this argument, of course, is that it assumes borrowers are prudent and rational, and therefore will plan their property purchases in ways that will save on unnecessary interest payments when they can.

For now, this seems to be the case, judging from the poor take-up rate of 50-year loans so far. Mr Khaw has said this is a "good sign that Singaporeans know we should always be prudent".

But supply has a habit of creating its own demand. Young couples now routinely have to pay at least $1 million for a small freehold private condominium unit, even one located in the suburbs.

Incomes have not risen as quickly as property prices, and you can be sure that at least some will consider taking the soft option of lower monthly instalments when it is made available to them.

If more of them do it on the misplaced assumption that prices can only rise, the practice can slowly get entrenched.

But borrowers could easily get stuck with a 50-year loan if the market crashes. More are likely to end up in negative equity, saddled with loans far larger than the value of their real estate if prices fall fast because less of the principal sum is paid off.

If rates rise as well, some borrowers could well be forced to sell and go bankrupt.

Mr Christopher Tan, chief executive of financial advisory firm Providend, said a 50-year loan could work for an investor if the market goes up but would cause a lot of pain if it heads south instead. It is a very risky move, he added.

"In terms of financial planning, it also doesn't make sense because you are obviously buying something you can't afford. It reflects the mindset of the buyer, and it is unlikely that he will be prudent later and pay off the loan earlier even if his salary increases."

This is why even though product innovation in a free market is usually a good thing as it provides options to customers, the Monetary Authority of Singapore (MAS) has said it is closely monitoring UOB's mortgage product.

The MAS has stepped in to regulate imprudent behaviour in the past. In the mid-1990s, it limited unsecured loans to individuals with salaries of more than $30,000 a year. They could also only borrow no more than two months of their salary. These rules have been relaxed only in recent years.

The authority has also lowered loan-to-value ratios on investment homes to protect investors from overstretching themselves.

But ultimately, the borrower must be responsible for his own welfare and do his sums.

There is nothing wrong with looking for a way to reduce mortgage payments when borrowers are young and cash flow is tight. There is also nothing wrong with banks rolling out new options to meet those needs. In Japan, the creation of 100-year multi-generational mortgage terms allowed for loans to be passed on to children and even grandchildren. But the market eventually collapsed, leaving many financially battered or even wiped out.

Western countries, in comparison, typically stick to 30-year mortgages.

Ultimately, borrowers must know the cost and do their sums accordingly. They must look beyond the short term and take advice from friends and family, and even the National Development Minister if necessary.

Still, given that these 50-year loans will target the younger set of borrowers who may not be that financially savvy, banks could take more pains to ensure that the risks are disclosed to them.

Although various measures are in place now to help borrowers make an informed decision - scenarios showing how interest rates may affect instalments - the MAS or the bank can consider what more can be done in this particular area. Banks could, for example, show that they have offered two other loan alternatives to borrowers, stating clearly the interest that must be repaid for each one.

While there are legitimate concerns that come with signing up for a 50-year loan, it does provide home buyers with another repayment option, though risky, that some may find beneficial.

Either way, home buyers and investors must take responsibility in the planning of their own finances. Part of that entails discipline and knowing one's limits.

Financial discipline - and not just the structure of a loan product - will be a key reason why one borrower defaults while another ends up with a roof over his head.

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