Singapore Home Loan: It is costly to stretch the Home Loan? Why do it?
October 15, 2008 by property
Filed under Compare Singapore Home loans
I remembered you told me that Stretching the Mortgage repayment
period incurs greater interest cost. If this is the case, why do some people still do it?
The may do it because of the following reasons: -
- Affordability.
- Financial flexibility (They may want to conserve cash for an unexpected rainy day or an investment opportunity)
- Investors seeking maximum return.
Investors seeking Maximum returns? How is that possible if they incur more costs?
It is possible through leverage.
How?
For example, an investor pays $1,000,000 for a property.
He leases it out for $5,000 a month, or $60,000 per year. (Nett)
- Assume the person leasing pays the 10% property leasing tax ($6,000)
- Assume the person leasing pays the Conservancy and Maintenance (roughly $4,000 pa)
- Assume the person leasing pays the stamp duty for the tenancy agreement (~$400 to $500 pa)
Investor yield is 60,000 / 1,000,000 = 6%
So he/she only makes 6% returns?
Actually it depends.
An investor/home buyer normally pays 20% down payment on a property. (Depending on the banks, some banks offer option to pay only 10% down payment)
If an investor pays $200,000 for a property worth $1,000,000. The investor’s invested capital is only $200,000 and NOT $1,000,000.
If he invests $200,000 and he earns $60,000. His returns are: -
- 60,000 / 200,000= 30% Gross.
If interest rates are 3% pa. That means, his cost of borrowing is: -
3% x ($1,000,000 -$200,000 down payment) = $24,000
His Net margin then becomes: -
- ($60,000 – $24,000) / $200,000 = 18%
But if he has to pay both Interest and principle, that means he would have to pump in cash in excess of his interest costs of (3% of $800,000 = $24,000).
Let’s say, his loan tenure is 30( years. The interest rates is 3%. Then his repayment would be around $3,372 per month. Or $40,468 per year.
The excess money he has to invest to pay down the loan would be: -
- $40,468 – $24,000 = $16,464 (in the first year)
His Newly calculated Net Margin would become: -
- ($60,000 – $24,000) / ($200,000 + $16,464) = 16.63%
Can you see that it has dropped from 18% to 16.63%
So if the investor borrows 90% and pays a 10% down payment, he would further increase his returns even if he pays higher interest rates?
It depends on what rates the banks offer. The banks typically charge a higher interest rates for large loan quantum (or Loan to valuation LTV). For example, the bank may charge a 1% loading on 90% loan to value.
So his effective interest rates would then go from 3 to 4%.
His New Return on Invested Capital would then be: -
- $4,296 per month repayment or $51,552 pa
- Or $51,552 – (4% of $900,000) = $15,552 pa in excess of interest cost
- (60,000 – (4% of 900,000) ) / ($100,000 + $15,552) = 20.77%.
The investor would then be able to increase his returns on invested capital to 20.77%.
So in this case, yes, stretching and borrowing more and using lesser capital will increase returns, subject to how much more interest he/she has to pay.
This is just a rough and hypothetical calculation, if you want more details, we would be happy to discuss this with you in greater detail.
Email or call us (SMS us) at 9782-8606
IS IT WISE TO SHORTEN MY LOAN AND PAY UP QUICKLY?
Housing loans are about the cheapest form of financing in the world.
- Housing Loans ~ 3%
- CAR LOANS ~ 6%
- Personal Loans between (8% to 16%)
- Credit cards between (16% to 24%)
If you can utilize the money in a "GOOD DEBT" form of way. I.e. you borrow
at 3% and make more than 3%, then the answer is a qualified YES.
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