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How To Right-Size Your Mortgage For Hard Times?

Hard times looming?  We are not sure really.  It could well be a V-shaped recovery too once the dust settles on corona virus outbreak. A lot depends on how long people stay away from consumption, how long more before supply chains are restored, and if businesses have the cashflow to wait out.

Still, this article will be a good read for homeowners and property investors looking to bring down their mortgage repayments or reduce their monthly commitments, whether hard times hit or not.  It’s good to stay prudent at all times.

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How do you reduce the monthly repayment on a home loan?  

It’s really not rocket science.  Banks use conventional amortization when determining how much you pay every month and there are only four variables in amortization – Principal amount (P), tenure (T), interest rate (I) and the monthly instalment (MI).  So if you want to reduce MI, you simply work on one or all of the remaining three other variables.

We offer you our views on how you can do that effectively for each of these variables.

1. Principal (P)

This could be the hardest so we start with Principal amount, or your current outstanding loan.

Why is this the hardest?  There are two reasons.  First, some of us simply do not have the “spare funds” to pay down. Second, even if we do have some spare funds, we are not quite sure how much of it to stash away for rainy days (or opportunistic investments), and how much should be used to pay down the outstanding loan.  You can’t prepay with all your “emergency funds” for sure.  Lest you are left high and dry when you need to use them. Financial advisors typically advise setting aside at least 6 to 12 months of your household’s income as emergency funds.

In our mortgage industry – there is one product that offers the best solution for this problem.  Many of you would have heard of an interest-offset mortgage account but are not quite sure how that works.  We have a case study written previously based on HSBC’s version called the SmartMortgage account.  It has the highest offset ratio of 70% amongst the three banks offering interest offset in the market.  As interest offset entails that you take a floating rate home loan, there’s no better time to consider such a loan feature as interest rates are expected to stay muted for a considerable time.

Whenever I talk about interest-offset, there is often a need to explain the confusion with returns from high-yielding instruments like bonds, REITs, SSBs (Singapore Savings Bonds) or even some savings account.  You cannot compare interest offset with returns from bonds and REITs are they are not like-for-like comparison.  Such instruments carry some risks (you may lose the principal value just when you need to withdraw), and they may also be illiquid.  

The more meaningful comparisons would be with some high-interest savings accounts the likes of DBS Multiplier Account, UOB One Account, StanChart’s Bonus Saver Account, etc.  But all these require you to fulfil some conditions every single month like card spend, GIRO, or do investments, etc.  Even the “most achievable” DBS Multiplier Account with no minimum amount to fulfil on each qualifying category (but just an overall transaction value every month) has recently halved the cap that you will earn interests on – from $50,000 to now $25,000 (based on fulfilling 2 categories).

If your emergency funds of 12 months of households’ income is $120,000 (assume average of $10,000 per month), you may need to spread your funds across a few high-interest savings accounts to maximize your returns.  This makes it onerous.  Alternatively, consider parking $25,000 in DBS Multiplier Account and transfer the entire remaining balance of $95,000 without qualms into an interest offset account.  Why? Because you could still withdraw or access those funds anytime at will, unlike fixed deposits or investments. There is no conditions to fulfil every month.  And there is also no cap.  HSBC’s SmartMortgage is giving you the highest offset interests on 70% of your deposits. Put it in another way – what you deposit will earn an interest equivalent to 70% of the mortgage rate you are paying.  With today’s average floating rate at 1.90%, that means for the $95,000 you park there, you earn a very decent 1.33% p.a. (70% of 1.90%) deposit interest.

And how does that bring down your principal loan?  As 70% of your deposits are earning the same mortgage rate which offsets the loan, you are effectively prepaying $66,500 (70% of $95,000) of your outstanding loan, but without actually prepaying.  You can still “take back” the money anytime you like and service a bigger loan.  Perfect.

Note in interest offset account, the MI does not come down.  The offset interest you earned on the deposits is used to pay down more of your principal outstanding every month instead.  Read our article on interest offset account.  To actually lower the MI, the quickest way is to work on changing the tenure or interest rate.

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2. Tenure (T)

If you have bought your property after Jun 2013 when the TDSR regmine kicks in, chances are you would be able to extend your loan tenure by rougly 8-10 years. This is because at purchase, MAS’s ruling requires that for maximum loan-to-value you need to keep the last age of loan servicing to 65 years old.  But banks can actually extend lending to the maximum age of 75 years old when you refinance.

How much will that bring down the MI?  Is there a tradeoff somewhere?

To illustrate we use a typical loan of $750,000 at today’s interest of 1.80% and look at two scenarios of over 20 years remaining tenure and extending that by 10 more years to 30.

T = 20 years

T = 30 years

By extending the tenure, the MI goes down by almost 30% ($3,723 to $2,697).  However, the total interests paid over the loan tenure would balloon from $143,638 (20 years) to $221,186 (30 years) – an increase of 50%!  

This move suits more of investors where a big portion of the MI is covered by rents from the tenants.  For own-use property – this remains more a short-term measure where the aim is to restore the tenure back to its original levels when one’s financial situation improves. But it does provide a quick short-term relief on monthly cash flow, which will be much appreciated when hard times hit.

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3. Interest (I)

Finally, reducing the interest rate through a mortgage review whenever your lock-in ends is a no-brainer.  And you would think everyone is doing that.  Ironically, that’s not the case based on what we see.

We have touched on this in our last article – majority of the clients who contact us for refinancing contact us too late!  Most end up paying higher interests over a 3-month notice period before their loan could even port over to the new bank.  That’s totally unnecessary and could be avoided.  And if you add the many 3-month’s notices over a 25-year loan tenure – it comes up to a substantial amount in the thousands.

That’s why you should work with a trusted professional mortgage broker who does this review with you early.  Not only will we save you thousands in terms of interests over 3-month notice periods, you’ll be assured of getting the lowest rate in the market each time you refinance your home loan.

Since 2014, MortgageWise.sg has provided thought leadership in the mortgage planning space in Singapore, seeking to build trust with clients over the longer term rather than product-peddling for quick one-time deals.  So, be it to refinance home loan, or to buy your next Singapore property, speak to our dedicated team of mortgage consultants here for the best home loan rates.

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