The initial article, Comments on the UOB 50 Year Loan, has attracted a quite a number of comments due to its to controversial nature.
I am expressing my opinion as an experienced investor having taken more than 10 property loans for my property investments. I have taken loans ranging in tenor between 20 and 40 years, so I am sharing my experience. If you do not agree with me by the end of this article, its ok as there is no right or wrong here. The usefulness of such a long tenor loan is subjective and vary from individual to individual.
So I would like to address some of the comments, particularly from B, k, Robin.
Goal of Property Investment
When I started my property investment journey, it was a long term goal to build up my assets. The idea was for the tenant to pay for my loan and by the time I retire I would have a number of fully paid up properties which can be used to fund my retirement with rental income. For my 20-30 year loans, the bank loans decrease at a good rate and I can see my equity in my property building up from both the capital appreciation and the debt paydown.
However, when I look at my 40 year loan, the loan amount has hardly moved from the date it started, even though the tenant has been paying for more than a year! While the housing price has appreciated, I have lost out on another source of value, which is the debt paydown.
While one may argue that I have more positive cash flow, which is true, but it ends up getting spent anyway. So the better option would have been to pay down the debt more quickly, its only like two hundred ringgit extra per month to reduce the loan tenor by a whopping 10 years! You can see it as a form of forced savings. Furthermore, waiting out the 40 year loan would put me at a age of close to 70, which is way past retirement age.
Tradeoff Between Extra Cash Flow and Loan Tenor
This is one of the main points and it bears repeating. The tradeoff between the cash flow saved and the time extended simply does not make sense as the tenor increases. Taking the example from the previous article, I have included another 60 year loan just for calculation sake.
Difference Between 10 Year Loan and 20 Year Loan – $3,288
Difference Between 20 Year Loan and 30 Year Loan – $1,064
Difference Between 30 Year Loan and 40 Year Loan – $509
Difference Between 40 Year Loan and 50 Year Loan – $288
Difference Between 50 Year Loan and 60 Year Loan – $179
So extra cash flow? It does not always make sense, the point is to set your loan at a optimal level which balances the extra cash flow and number of years you will be paying the loan for.
Minimum Loan Repayment Per Month = Interest Payment
How much lower can the monthly repayment go to you wonder? It goes to the point where your loan repayment is exactly the same as the interest payment, making it close to being an interest only loan. Following the same case above, interest per month at the start of the loan is $2000 and the 50 year loan repayment stands at $2,576. So your monthly repayment can only go down by close to another $570+ no matter how many years you stretch. So again, the idea you that must always stretch to the maximum loan tenor is not always true.
The Stability of Rental Income
Some would argue that low monthly repayment means more cash flow. While that is true to a certain extent, the point is only as valid as the stability of the rental income from the property. You are assuming that the property will always be rented 100% of the time with no vacancy periods. If your property is not rented, you have to use your active income to pay for the loan while waiting for a tenant.
It is usually easier to rent when the property is newer, after that tenants will always go for the newer, fresher properties so tenant retention may require somewhat lower rentals. So the idea is that while your property is hot and easy to rent, try to pay off the loan faster so that you mitigate some of your cash flow risks as the property gets older. The last thing you want is to have a couple of vacant properties with loans still outstanding and you are unable to retire despite hitting retirement age because you have to pay for the loans.
The Longer The Loan Tenor The Greater The Effect of Volatility In Interest Rate
Interest rates are also cyclical, just like any assets. The longer your loan tenor, the greater the effect of interest rate hikes will have on you. To put it in a simple manner, a 1% hike in interest rates will have a larger effect on a person with a 50 year loan compared to someone with a 30 year loan. Not only does the monthly repayment rise at a higher rate, the total interest also increases much more for the 50 year loan.
|30 Years Tenor Monthly Repayment||$2957||$3373||$3819||$4295|
|50 Years Tenor Monthly Repayment||$2110||$2576||$3086||$3633|
Bad for the Economy, Causes Further Inflation in Housing Prices
Allowing these 50 year loans to become a norm will undermine the government efforts to stabilize housing prices. It distorts the perception of affordability, making people think that they can buy a more expensive house even though their income remains the same. This can overheat the market, causing inflation figures to become even higher. This is also bad for investors as it can cause huge volatility and extreme prices in the cycles. Prices can become more overpriced and when the correction comes, it will hit everybody much harder.
I have stated my position and I prefer that the banks don’t follow and start rolling out longer and longer tenor loans. I have also explained in detail why I personally feel strongly against these extremely long tenor loans as an investor. So I hope I have answered some of the comments from the previous article here.
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