April 20, 2008

small change

You can take a cash-out loan from your home

By Bryan Lee, Economics Correspondent

As a mortgage war breaks out among Singapore banks, homebuyers have emerged the clear winners as lenders slash interest rates to grab new customers and retain existing ones.

Rates have plummeted to less than 2 per cent. This means borrowers are effectively getting free cash as sky-high inflation means their future repayments are worth a lot less than the initial loan.

That is great, of course, for young couples buying their first home and moneyed investors looking to take advantage of the cooling property market. But they need not be the only ones reaping the spoils of the rate-cut battle.

Those of us who already have a roof over our heads but are not ready to take the plunge on another property can still benefit from the rate slashing that is going on.

If you have a private property that is at least partly paid up, you can consider taking a loan, using the paid-up bit of the house as collateral. Often called a home equity loan or a cash-out loan, this facility is pretty much like a mortgage, with similar rates and terms.

But instead of using the money to pay for a house, you can use the cash any way you like - whether to splurge on a new BMW, pick up some undervalued stocks or finance that one-man business which you run out of your study.

As mortgages are just about the cheapest loans available in town, this slightly off-beat idea could yield some interest savings.

It is also one way to cash in on the recent property boom without selling your house. If you own a house that is now worth more than what you had bought it for, banks will be willing to lend you more money than before as the collateral base has grown.

These property-backed loans are common in developed countries, from the United States to Australia.

But bankers say conservative attitudes towards credit and a certain sanctity Asians ascribe to their homes mean relatively few people, in Singapore and in the region, have taken advantage of this cost-saving option.

So far, equity loans in the local market are used mostly by entrepreneurs as a cheap way to finance anything from business expansions to day-to-day transactions. But with mortgage rates so low - and they may fall further - it might be time to take another look at tradition.

Ignoring absurdly low first-year teaser rates, home loans are now going for between 2 per cent and 3 per cent in interest charges. Add a small premium that is typically charged, and equity loan rates are now around the 3 per cent mark, say bankers.

This is clearly cheaper than unsecured credit lines, where rates go into double digits. It is also cheaper than loans for small businesses, which typically face rates of between 7 per cent and 8 per cent.

What about car loans? At 2.5 per cent, they look cheaper. But interest for these is charged on the full loan amount throughout the tenure of the loan. In contrast, regular loans charge interest based on the outstanding principal as the loan is repaid. The effective rate for a car loan is thus roughly about twice that of the advertised rate.

Standard Chartered Bank general manager for lending, Mr Dennis Khoo, says that for a $40,000 loan stretched over six years, interest savings could come up to about $2,000, if one took up a home equity loan instead of a regular car loan.

Sounds good. So, how does one go about getting an equity loan? How much can one borrow?

The process is largely similar to that for a regular mortgage.

Take, for example, a $1 million house. A bank would typically allow for total borrowings on the house of up to 80 per cent of the property's value - or $800,000.

If there is an outstanding mortgage of $300,000, the biggest equity loan that can be granted would be $500,000. But if the home owner had also used $200,000 of his Central Provident Fund savings to pay for the house, the maximum would be $300,000. This is because if there is a default and the house is sold off, proceeds will first go towards repaying the mortgage and replenishing the owner's CPF account, before they can be claimed by the equity loan provider.

Besides home valuations, banks will also look at the borrower's income to make sure he can service the monthly instalments, given his existing financial commitments.

But before you dash out to the nearest bank branch, remember that while they are cheap, equity loans should not be taken recklessly. To cop a familiar slogan: Low interest does not mean no interest.

In fact, more caution is needed as what is at stake may be the home that you live in. Furthermore, bankers warn that a property market downturn may prompt lenders to pull back on the loan as the value of the collateral falls.

If anything, the ongoing financial crisis is a stark reminder of what happens when credit is abused.

The lure of cheap credit, along with a housing boom, led American households to overspend massively in the past decade. Now that the housing bubble has burst, they are finding themselves a lot shorter on cash, with a great number struggling to keep their homes from being repossessed by their lenders.

The point is that one should not let the promise of 'a good deal' override prudence and common sense.

The equity loan is best seen as a way to reduce financing costs that you would have incurred anyway. Taking on an unsustainable financial burden just because it is cheap can turn out to be a costly decision.

So be shrewd with your borrowing, but be wise with your spending as well. Or else, you may find that splashing out on that flashy convertible may leave you all washed up - and without a roof over your head.

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