19 July 2005

Aha! Another Financial Planning Question

KiddyBoy would like Mr Wang to comment on this:

"I have a friend, just married and lives in a lovely but huge HDB flat. Just two of them. Price of flat stunned me, almost 300K. Friend tells me loan is for 30 years (no choice leh, he says), and by my quick calculation, total interest payment can buy a Subaru WRX (My dream car!) at today's prices.

I also have a colleague, about to buy flat. He has PhD in Engineering, and tells me, "I did my calculations and it seems to me that I should take the smallest loan, or to put it in another way, buy the smallest flat. Then I can slowly upgrade along the way when I have kids etc etc". PhD-colleague says, "unlike buying shoes, buying flat is not a decision you can reverse easily".

I think - I am inclined to agree with PhD-colleague, and hope that if I do get a wife, the wife is not the sort who wants big flat."
Today Mr Wang is busy. So he will do a short reply. First - a side note. Read tomorrow's newspapers. Mah Bow Tan will be announcing some policy changes to excite the property market. ("Damnit .... how on earth does Mr Wang always know these things?!")

Now for the question proper. A 30-year housing loan need not actually be repaid over the full 30 years. Along the way, you can make prepayments. This means that if you have extra cash, you can prepay part of the loan ahead of time. Thus you can repay the full loan sooner than 30 years. By prepaying part of the principal loan amount, you also reduce the interest you have to pay each month.

Many newlywed couples who have just purchased a home do not think that they can afford to make prepayments. They look at their monthly salaries and expenses - nothing much is left over. However, what they earn today is not what they would be earning in five or ten years' time. With a little bit of luck (that is, their careers go well and they don't get retrenched), they will steadily earn more and more over the years, and save more as well. Prepayments then become possible.

Check with your bank to find out the prepayment conditions. Some banks have an initial lock-in period (for example, no prepayments in the 1st three years). Some banks may impose administrative charges or a prepayment fee. Most banks will also have a minimum prepayment amount (for example, at least $10,000 per prepayment). And so on.

Buying a smaller flat, with a view to upgrading later, is not necessarily a good idea. Each time you buy and/or sell a property, you incur certain costs (property agent's commission, stamp duty, legal fees, administrative costs). If you buy twice, you incur the fees twice. If you buy thrice, you incur the fees thrice. The fees can add up to a significant amount. If you renovate your flat very nicely and then move out within a few years, well, that is also a waste.

On a more philosophical note, Mr Wang notes that life is not all about money. In particular, buying a property is not all about money (unless the property is purely for investment purposes). Some things just cannot be reduced into pure dollars and cents.

Mr Wang lives in a HDB flat. Although Mr Wang can definitely afford a private condo, he intends to continue living in his humble HDB flat for many, many years to come. Why? Because it is Mr Wang's home. He feels happy in it. It is the home that Mr and Mrs Wang built together. Many fond memories are here.

Besides Mr Wang's favourite roti prata stall is nearby. Mr Wang MUST have his roti prata every Sunday morning.

Mr Wang is not sentimental about his bonds or equities - he will buy, hold or sell without emotion. But roti prata - ahhh, it is just not the same.

Roti prata -
a major influence on Asian property markets.


Ellipsis said...

i like your comment about the home you and mrs.wang built together.

I moved only recently, and that for the first time in my life too. as i made my way out of the iron gates for the last time, I felt the unbearable weight of sadness again. that was my home and a place that had seen me grow into the person I am today, and I had to give it up to someone else who looked at it with like a piece of property, something that could be haggled down like meat in a market.

nice philosophy indeed; better a small cosy home than a large, cold house.

Norman said...

Of course, I won't advocate selling/buying with such frequency such that the fees add up.

However, I also don't think maxing out duration and loan amount is a good idea, which is what PhD-colleague does not want to do anyway.

Agree with the prepayment thing. At next opportunity, will advise Friend about this possibility.

However, it boils down to the fact that it is better to work towards a debt-free life quickly and thus not worry about shocks (like retrenchment, illness) right?

Agree will ball.of.yarn -> what is the point of expensive flat if you have to work your ass off to pay off the loan?

Anyway, bringing in the issue of costs makes it very tempting to start crunching the numbers. Heh.

This is the one and only KiddyBoy!

. said...

well, mr wang is absolutely right again!!! he missed out on the issue of inflation, though. i'm one of those victims who got caught in the hdb transfer market. not exactly me - it's my dad (but he is totally broke now, so my siblings and i have to service the loan for the next 15 years at $1000+/month in cash and that's for a 4-room unit only).

the methodology proposed by the phd colleague in the article is similar to that used by my father (except that it started more than 20 years ago in my dad's case). we've moved around a number of times and were caught by the inflation as singapore progressed - from 3-room (new, $15k in 1979) to 3.5-room ($54k in 1986) to 4-room ($85k in 1989) to 4-room (new, $98k in 1997) to 4'a'-room ($220k in 2002).

granted that the rate of inflation may not be as high as before, the phd colleague mentioned by kiddyboy is risking paying today's prices using today's money if he upgrades a couple of times in future. he would therefore be worse off compared with the scenario of paying yesteryear's loan using today's money.

of course, the phd colleague may be better off if future policies by the government cause a significant drop in property prices. however, he will not be disadvantaged if he purchased a large unit now using an extended loan period as long as he pays using cpf and the amount paid up is less than the selling price in future.

Gilbert Koh aka Mr Wang said...

One thing to bear in mind is that you always need to have a roof over your head.

If you buy a property and live in it, don't get too excited when the market heats up and the market value of your flat increases. Even if you sell and make a profit, you still have to buy another place to live. And since you cannot be homeless for too long, you need to buy the new place around the same time, which means you are also buying in a rising market.

From a pure investment point of view, property actually has many disadvantages unless you're really very wealthy. You have to plonk a lot of money into a single asset and you can be locked in for a long time. Also, unless you're so rich that you can buy your property without borrowing anything from the bank, your investment is actually leveraged, and usually a lot. Which means that you're borrowing to invest. That's dangerous.

Norman said...

Let me frame the issue in a narrower way.

The question is thus asked, For a home purchase (ie. not investment), is it a good thing to max out the duration of the loan and the monthly instalment?

My answer is that it is not. All is well if you have your job for life and your pay goes up in a straight line and you are healthy. However, my reasoning tells me that it is good to leave some flexibility to reschedule the loan when a shock (illness, retrenchment) occurs. What does Mr Wang and the other blog readers think?

Gilbert Koh aka Mr Wang said...

I agree with you that it is not safe to assume that you have your job for life; will steadily earn more and more as the years go by; and will remain healthy indefinitely etc.

However, this actually means that you cannot seek to pay off your housing loan so aggressively. For example, if each month you put as much money as you can towards repaying the loan, you shorten the life of the loan but you also make it impossible for yourself to build any emergency reserves.

You can aim to repay a 30-year loan in 20 years, but if you stretch yourself too hard, then you are in deep trouble if, in Year 5 or 6, you become unemployed and you can't even meet next month's mortgage payment or even next month's water bill (because you never had any savings - you'd thrown all your money into repaying the housing loan as fast as possible).

That is why I prefer the prepayment strategy. You prepay as and when you have more than enough, and you only prepay the amount that you're comfortable with. For example, if you got a big bonus in December, then you prepay in January using your bonus.

Norman said...

okay, analytics88, what instruments are there that *guarantee* 6% yield?

Gilbert Koh aka Mr Wang said...


And you need to retake your PSLE maths.

Suppose you have an outstanding mortgage loan of $400,000 and you are paying interest at 2% p.a.

Then suppose you have $40,000 excess cash which you THINK you can invest in instruments to get about 6% p.a.

Firstly, note that 2% of $400,000 is a lot larger than 6% of $40,000.

Secondly, note that your 6% is not guaranteed. Investing always has risks. Your 6% could jolly well turn out to be -6%.

Thirdly, note in contrast that if you instead apply your $40,000 towards reducing your mortgage principal, you WILL definitely get a reduction in subsequent interest payments. Unlike the case of your investment, this reduction is GUARANTEED. The bank cannot chare you interest on what you don't owe it.

Furthermore the savings in interest payments is not just for this month, not just for next month -

but for every month of the rest of the life of your housing loan. That is, the next 15 or 20 years.

So once again - *yawn*.

If your strategy is so good, banks wouldn't be in the business of housing loans. Instead of lending to you, they would rather just take their own money and go invest directly in the wonderful 6%-guaranteed investments you mentioned.

There are other subtleties in my advice which you obviously missed. But more on this later.

Gilbert Koh aka Mr Wang said...
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Gilbert Koh aka Mr Wang said...
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Gilbert Koh aka Mr Wang said...
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