Buying a home with a pricey home loan can still make sense

Oct 11, 2022

Interest rates are rising – the three-month compounded Singapore Overnight Rate Average (Sora) has soared from under 0.2 per cent per annum at the start of the year to nearly 2.2 per cent as at value date Oct 7, 2022. A floating rate home loan that is pegged at 1 per cent plus three-month Sora will now cost around 3.2 per cent per annum.

Thus far, Housing Development Board (HDB) resale and private homes prices in Singapore have been resilient. Based on flash estimates by the Board and the Urban Redevelopment Authority, HDB resale and private home prices in the third quarter of 2022 are up 11.4 per cent and 13.2 per cent respectively from a year ago.

Rising home loan rates may not deter cash rich buyers, save there is opportunity cost when deploying funds to buy homes.

Still, many homebuyers borrow. Perhaps, the interest rate hikes to date are manageable. But, the United States Federal Reserve, which has been actively raising interest rates, is signalling further rate hikes.

Homebuyers may feel the pain should interest rates rise to 4 per cent or more per annum. For a 25-year loan of S$750,000, the monthly repayment is S$3,365 assuming an annual interest rate of 2.5 per cent, and S$3,959 or 18 per cent more, at a 4 per cent interest rate. Currently, DBS offers fixed rate home loan packages where borrowers can lock in an interest rate of 3.5 per cent per annum for two to five years.



Lending by private financial institutions to homebuyers is subject to loan-to-value (LTV) limits, as well as caps on total debt servicing ratio (TDSR) and mortgage servicing ratio (MSR). The TDSR cap on the portion of gross monthly income that goes towards repaying monthly debt obligations, including the loan being applied for, is 55 per cent.

The MSR cap of 30 per cent on the gross monthly income that goes towards repaying all property loans, including the loan being applied for, applies to buyers of HDB flats and executive condominium (EC) units, where the EC’s minimum occupancy period has not expired. An interest rate floor of 4 per cent per annum is used to compute TDSR and MSR for home loans.

Historically, homebuyers have paid over 4 per cent per annum in home loan rates, such as in the late 1990s when my wife and I bought a home. Perhaps, we did not over-analyse the risk of being unable to service a relatively expensive multi-year home loan.

For young couples, signing a 25- or 30-year home loan can be daunting in an age, where disruption means there is often little visibility on job security. I suffered from retrenchment in 2002 while servicing a home loan. Fortunately, having a working spouse helped in giving some peace of mind to being able to make monthly repayments. Also, I managed to land a new job shortly thereafter.

Over the years, my wife and I received some pay increments, and I made some capital repayments on the home loan from the occasional healthy bonuses. All this helped to make servicing a home loan more manageable.

Borrowing at 4 per cent interest rate

It can make sense to take a multi-year loan to buy a home, even if home loan rates reach 4 per cent per annum.

Firstly, assuming a home generates an annual total return of over 4 per cent, funding its purchase by borrowing at 4 per cent per annum can make sense. If a home generates net yield of 2 per cent and capital gain of over 2 per cent per annum, the annual total return will top 4 per cent.

Secondly, a non-homeowner may incur home rental costs. One may spend close to the monthly repayment amount of a home loan on paying rent instead. When one buys a home, one owns an asset, which can appreciate over time. Also, one can use CPF funds to service a home loan, but not rental payments.

Thirdly, even if home loan rates here hit 4 per cent per annum or more, rates may not stay at such levels over a prolonged period. Central banks could lower interest rates should economies hit hard landings. With ageing populations in many places, higher savings rates could help rein in the level of interest rates over the longer term.

Moreover, servicing a loan can become easier over time should a borrower’s economic circumstances improve, albeit one needs to watch out for rising expenses due to caring for children or the elderly, for example.

For some people, it can make sense financially to opt to permanently rent a home instead of buying one. Monies tied up in funding a home purchase can be freed up to invest in a promising business or investments that may offer higher returns versus homeownership.

Still, some people may end up spending more on consuming goods and services that provide no investment return, if they were not tied down to servicing a home loan.

Tighter borrowing limits

In this year’s National Day Rally speech, Prime Minister Lee Hsien Loong highlighted how an estimated 150,000 new homes can be built in the future town in Paya Lebar after the Paya Lebar Air Base relocates in the 2030s. Lee gave the assurance that Singapore would not run out of space in the future, and that housing would be available and affordable.

Building new homes to meet demand takes time. Recently, the government acted to promote sustainable conditions in the property market by ensuring prudent borrowing and moderating demand. Measures affecting borrowing that kicked in on Sep 30, 2022, include higher interest rate floors to compute TDSR and MSR, as well as the eligible loan amount for housing loans granted by HDB. The LTV for HDB housing loans was lowered to 80 per cent, from 85 per cent previously.

As home loans get costlier and economic conditions turn nastier, new homebuyers need to be extra prudent when signing multi-year home loans. Still, the ability to gear up helps young adults to realise their homeownership aspirations. A young adult, with no parental help, may need to secure a big home loan in order to bring forward his purchase of a home in which to build memories. Hopefully, first-time homebuyers will not see more curtailing of their ability to borrow.

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