Today, MAS decided to announced a tweak to their total debt servicing ratio (TDSR). The TDSR is a financial prudence ratio that only allows banks to led money to family, whose total debt is not more than 60% of their income.
The new rules:
- allow property owners who bought their housing after the TDSR is in place and currently violate the TDSR limit, to refinance their loans. Previously this can only be enjoyed before the TDSR was introduced
- TDSR for buyers did not relax
To benefit from this new rule, the borrower needs to commit to a debt reduction plan to repay at least 3 per cent of the loan’s total outstanding balance over three years.
I like that they keep the TDSR, though these changes, after they say they won’t relax the property laws, is unsettling they will release this to halt a future crashing market.
However, from the increase leeway MAS is allowing, I struggle to think how these leeway will improve the situation.
How can you improve a bad situation?
I tried my best to think of a few scenarios to see how these rules can improve the situation but I struggle to find them.
There are 3 scenarios where it make sense for you to refinance:
- ‘Cash Out’ Refinance
- Swapping Interest Rate Type
- Extend Loan Tenure
#1 works out well when you bought a condo valued at $1 mil with $800,000 mortgage. A few years later, when your home is valued at $1.5 mil, you can do a refinance at 80% loan to value. This will net you 1.2 mil in loan.
The net cash flow might be $400,000+- ( you would have paid down a small part of your mortgage).
Instead of waiting for your rental cash flow, you can put this $400,000 to work in another investments or for the down payment of another condo (be aware that the mandatory down payment for a second property will be higher)
In this current climate, since 2013 when the TDSR was established, the value of the properties in general dropped 10%. This ‘cash out’ refinance scenario is highly unlikely.
#2 is likely. You might found a mortgage with fixed loan rate, in anticipation that rates will rise. Now that you are in a cash crunch, you will find any sort of ways to reduce your monthly cash out flow.
For example, suppose you bought a 3 bedroom condo for $1,500,000 in 2013 after the TDSR. Now your home value drops by 10% to $1,350,000. On a Loan to Value of 80% you can at most borrow $1,080,000.
3 years have elapsed and your principal loan amount have gone down from $1,200,000 to $1,086,159.
There is no difference there!
A refinance could net you a saving of interest payment monthly. If your interest rate drops from 2.3% to 1.3%, your monthly payment will fall from $5,249 to $4,214 or $1,035 in savings.
In the grand scheme of things, the reason you breached the TDSR, is because your income have ‘stepped down’.
What is the likelihood, a saving of $1,035 will vastly alleviate the situation?
It will alleviate the situation only if you flirt very close to the TDSR when you purchase the private property, and you managed to find a new job that pays less but a 10-20% pay cut. If it is a large pay cut, especially if you are a high income earner, this situation may not help much at all.
#3 is possible if you are 35 years old and below, and can extend a 25 year loan to 30 year loan and not breached 65 years old. If you are older than that, you will not be able to breach that mandatory age limit.
If you are 35 years old and below, you can further reduce your monthly cash expense down to $3,620 or a reduction of $594 more.
Do note that the following examples do not factor in any refinance costs. Usual refinance may ask you to down pay more to push through the refinance. If you have a cash crunch and they do still require you to pay this amount, this refinancing option is out.
Negative Cash on Cash Return Greater than Refinance Savings
For some, their condo is considered an investment property and rented out.
In this climate, where jobs are challenging and some expats are living the shore, rental competition is much tougher.
This means that vacancies go up and if you want to help pay the mortgage, you better reduce your rent.
Continue with the previous example, the same $1.5 mil condo now rent for $3,800/mth or $45,600/yr. The EBIT after expenses is $35,750.
If we deduct the mortgage payment of $5,249/mth, we get a negative cash on cash return. This means you need to come out with $2,330/mth from your pocket.
Compare this $2,330/mth to the $1,600 savings from the previous refinance exercise.
This exacerbates the lower pay issue.
How do you commit to a debt reduction plan on top of a struggling current mortgage?
If the rule is that you commit to a 3 year outstanding debt reduction plan, how do you find the cash flow to pay existing mortgage AND outstanding debt?
Unless you have an emergency fund, I don’t see how a person could crawl out of this situation.
Many people live on a very tight cash flow budget, without a budget.
Majority lived paycheck to paycheck.
By refinance and committing to such a plan, it means more additional cash out flow. This is likely to make the situation worse.
The banks are having a tougher time?
The bank’s job is to lend money to businesses and it is up to them to assess who they should lend to so that they can collect back the interest and principal.
Competition causes the banks to reduce the clients that passes their risk assessment.
In recent times, you have heard of Swiber’s demise which puts the banks with big exposure to oil and gas industry to be under scrutiny.
This move may be looked upon partly as a way of having more non performing loans, should more private property owners be unable to pay up.
This enables them to continue paying and not laden the bank’s balance sheet with more assets classified as non performing loans.
Although, I think the effect like any of the previous points, I doubt this will help the banks much, if really, only 2.5% of new home loans are above the TDSR threshold.
What this tweak signals of the health of the economy
My reading of the tweaks and its impact is that the affected group of borrowers that fall into this group is small and that the majority of the borrowers are not in a dire situation.
These tweaks allow those who has a step down in gross income to have more breathing room.
The outstanding loan amount that the borrower have to repay in 3 years should be small.
If any of the above situation is magnified, then these tweaks would not help much.
The question on many of our mind is that is this the real situation or will this be ineffective policies?
It will depend on what you are seeing on the ground. I am rather insulated. I would tell you, from what I see, that my on the ground assessment is similar to the situation based on these TDSR policy tweaks.