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Further Comments on the 50 Year Loan

08.15.2012 · Posted in Real Estate, Singapore

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.

Interest Rate 2% 3% 4% 5%
30 Years Tenor Monthly Repayment $2957 $3373 $3819 $4295
Difference $416 $446 $476
50 Years Tenor Monthly Repayment $2110 $2576 $3086 $3633
Difference $466 $510 $547

 

 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.

 

For further information, you may be interested in:

Comments on the UOB 50 Year Housing Loan

Additional Stamp Duty For Singapore Properties

Bank Negara Measures Taking a Toll On Housing Prices

6 Reasons Why You Should Invest In Property

My Interview on Next Insight – The Rewards of Investing In Property

The Trouble With Shoe Box Homes

Reader Questions and Answers on Leasehold Condos, Mickey Mouse Apartments and Investments

21 Responses to “Further Comments on the 50 Year Loan”

  1. Hi Calvin, thanks for the insightful post!

    Just wondering, in SG context, for people looking to flip industrial properties within say 2-3 years and the properties are still under construction now (no rental income), is it better to take a long or short tenor? Would it have any impact on profit margin?

    • Hi bc, no problem!

      The 50 year loans are only applicable to houses. For most industrial property loans, the maximum tenor should only be about 20-25 years. For flipping purposes, of course the longer tenor the higher your returns on capital invested. As shown in the above article, it definitely makes sense to take a 20-25 year loan instead of 10-15 year loan as the extra cash flow is substantial.

  2. If a 50-year loan can allow someone to buy a bigger or better property to gain a better rental yield, I still don’t see why this is a bad thing.

    For example, if someone can only loan S$800,000 with a 40 year loan, he can only buy a S$1 million property, which maybe a 3 bedroom condo far from CBD or a 2 bed-room condo nearer to the city. But with 50 year loan, he can now loan S$1 million and buy a S$1.25 million property, which can now be a dual-key 4 bed-room condo far from CBD or a 3-bedroom property nearer to city. This, in turns means a higher rental yield for the buyer, which in current market, will more than easily offset the low interest rate of the bank loan.

    Hence, I still do not see why this is a bad thing to the investor. Of course, if the property is meant for stay and not for rental, that maybe a different story.

    Again, my personal opinion, no offence meant to contradict your view.

    • Hi Daniel,

      No problem, everybody has their own opinion.

      A bigger and so called “better located” property does not equate to a better rental yield. The gross rental yield is a figure calculated from the rent psf and the value at which you buy the house.
      Gross Rental Yield = Annual Rental / Value of Property

      For e.g. A HDB can easily have a higher rental yield than a condo because it is much cheaper in price and it can still fetch a decent rent. In fact, many luxury properties have far lower rental yields than the mass market properties because the price of the luxury property is so much more expensive relative to the rental it can fetch. Many Sentosa condos have negative cash flows.

      So the amount that a person can loan does not affect the yield, it only changes how expensive a property one can purchase.

      Conversely as I stated in the article, it may give wrong perceptions about affordability and cause a person to buy a much more expensive property than what he can afford in reality. Such long tenor loans actually has the effect of pushing down gross rental yields of properties even more as the required rental to attain positive cash flow is lower. Combined with extremely low interest rates, it has the potential to create a devastating housing bubble.

      • Hi i agree with Calvin, i also notice in general higher price, bigger property (perhaps except better location) always give lower rental yield, something like diminishing return, perhaps more on capital appreciate, who know? Hence 50 years tenor is not good to link with affordability but as a cheaper source of financing, or giving better opportunity for those who can make higher return with the extra cash flow, and lesser possibility of default payment as compare to shorter long tenor due to lower monthly payment.

      • Hi Calvin,

        Let’s use a practical example for illustration. Using your assumption of 2% interest rate (current interest rates are lower but just for simple illustration), if one can afford to loan $800,000 for his first property and pay $200,000 for his 20% downpayment on it with a 30 years loan (let’s ignore the stamp duty for easy calculation), with a 50 years loan at 2% interest rate, he can now afford to borrow around 1.4 times more than the 30-year loan, based on the same monthly repayment he has to make. Hence, he can now take a loan of $1.12 million and buy a 1.4 million dollar property (BUT he needs $80k more for 20% downpayment) instead of a 1 million dollar property.

        Let’s assume that for the same condo that he wants to buy somewhere far from CBD, with 1 million dollar or 30 year loan, he can buy a 3-bedroom condo whereas with 1.4 million dollar or 50 year loan, he can now buy a 5-bedroom condo (it’s rare but they do exist). Originally, with 30 year loan, he can buy the 3-bedroom and use It for his own stay with his family BUT with the 50 year loan, he can now buy the 5 bedroom and rent out 2 of these room for $1000/room each, giving him an extra $2000 income per month.

        Hence, instead of paying $2957 per month for 30 years originally with a 3 bed-room condo, he pays only a net amount of $957 per month for 50 years with a 5 bed-room condo, assuming he can always rent out 2 of the rooms for that 50 years.

        Using this illustration, it means now he only has to pay a total of $574,200 for 50 years and gain a 5 bed-room condo as his asset at the end of 50 years instead of a total of $1,064,520 for 30 years and gain only a 3 bed-room condo as his asset.

        Hence, I still do not see why this 50 year loan is a bad thing if you use it in the right way to accumulate wealth, just like the illustration I gave. Of course, some may argue that I’m very optimistic that the 2 bed-room can always be rented out for the entire 50 years at $1000/room BUT note that this calculation is not taking into account of inflation yet. Do you think a room in a condo will still cost only $1000 to rent after 50 years? Moreover, do you think the 5-bedroom condo will still cost only 1.4 million in 50 years time, given the limited land space we have in Singapore?

        But still, I would like to hear your views on this illustration since you’ve owned many properties in Singapore whereas I’ve only own a 5-room HDB for my own stay and I’m no way consider as a property investor except for the numerous S-REIT I own… :-)

        • Hi Daniel,

          Your example has far too many assumptions which may be a bit optimistic. You are assuming that as an investor, you would rent out rooms in your own condo. However, I will never do that as it invades my privacy, I will only buy a unit and rent it out fully. Also, you assume that the rooms will be rented out all the time, which will never be the case.

          If you cannot afford the 5 bedroom without a 50 year loan, you simply cannot afford it. If you can buy the 5 bedroom with a 30 year loan, then of course renting out extra rooms will give you more cash flow, but at the expense of your own lifestyle. However, you should not take the 50 year loan just so that you can barely afford the 5 bedroom, because when the economy turns against you and you cannot rent it out, you will be in deep trouble.

          Always take into account the downside scenario, can you afford to make installment payments if the rooms are not rented out for an entire year? Or they are only rented out for 50% of the amount? What if you lose your job at the same time? If you cannot handle it, you cannot afford it. If you can handle it, why not just take the 30 year loan and own the property free of loan by the time you retire.

          Also remember that by the time you retire at 60, assuming you are 30 years old now, you still have to pay 20 years of installment. What if you can’t rent out the rooms then? You no longer have active income to pay for the installments and you have to use your retirement savings to pay or you may have to sell your house.

          All I am saying is that as a property investor, you cannot overcommit. Buy with long term in mind, buy within your means and it will be less stressful and you will have lower risks.

          • Hi Calvin,

            In my illustration, whether is it 30 year loan or 50 year loan, one still pay the same amount of monthly repayment of $2957. Hence, whether one lose their job or not will subject the person to the same issue of having to cough out $2957 per month, regardless of 30 or 50 years loan. Unless you project one to lose their job 30 years later, which I agree that chances are there since he or she is most likely beyond 60 years of age.

            Similarly, surviving without tenant will at most set you to pay the same amount of rent monthly as if you have needed with a 30 year loan without tenant. As such, again, I don’t see how it can impact a person unless you are again talking about survival after 30 years.

            With regards to invading privacy, yes, this is definitely a point of concern. However, how about those 4-bedroom Dual Key units where you rent out a Studio self-contain 1 bedroom with Kitchen and living room for $1500-$2200? That to me doesn’t compromise as much since I don’t have to see my tenant until it’s time to collect rental from him.

            However, I certainly do see your point and they are certainly valid concerns.

            I’m wondering how did you afford to own numerous property in Singapore at such a young age considering the various measures put in by SG government to make it difficult to do it. For me, I’m still struck with my first HDB loan, meaning if I’ve to buy another property, I need to pay 40% down payment for it, which is quite crazy. I do have around $300K in total for that to buy another $750K private property for investment but I’m not sure if this is a good move at this point in time. Cause my $300k are currently mainly in REITS and high yield stock yielding at least 5% dividend, meaning that generate around $15K for me per year, excluding capital gain in prices from them. If I buy a $750K private property for rental, I may get around $2.5K per month or $30K per year from it but I’ll incur a $450K loan that I need to repay. Using a 30 year loan, that means a repayment of $1553 per month, leaving me a net of only $1K per month gain from it, something worse that returns from REITs and high-yield stocks.

            What will you do if you are in my shoe?

          • Hi Daniel, as long as you understand the risks of stretching the loan beyond retirement, its your choice how you want to structure your investments. There are no rights or wrongs, it’s a risk/reward payoff and how much risk you are willing to take.

            Dual key units are relatively new, I do own a dual key unit in Solaris Dutamas. However, the fact that the water and electricity bills are shared through a common meter, monitoring them is a huge pain in the neck with 2 tenants. To make matters worse, there are no aircons in the development, only central chilled water and the chilled water bills are enormously high. If you charge one unit fixed rate, then they will have no incentive to save on the utilities and leave it on 24 hours. Just some practical considerations there most people never think about until they get stuck with such cases.

            For me, I bought the properties before all the measures kicked in and when prices were still quite reasonable. After the measures kicked in, I moved to industrial property but even the industrial prices are rather high now. Also, most of my properties are in KL.

            At this point, it doesn’t make sense to invest in Singapore properties as the prices are at all time high and upside is minimal with already extremely low interest rates and government measures. If I were you, I would stick with the dividend investments and wait for either a correction in property prices or cyclical stocks. When you want to buy an investment property, you may want to consider paying off the HDB loan first so you can get 80% LTV on the investment property.

  3. Great sharing!!

    I am into property investment now. How would you view the properties in Singapore And Malaysia? I have purchased a property in KL near bukit bintang. Hope to hear from you. thanks.

    • Hi Dave, excellent. Which property is that? I feel that prices in both Singapore and Malaysia are rather high, so I am not looking to buy anything new. In fact, I sold a couple of properties to realize profits and keep cash while waiting for the next opportunity.

  4. Hi Calvin,

    Thanks for sharing your practical experience. Indeed, many things I’ve not thought about because I’ve never experience it. Hence, it’s indeed a great honor and pleasure to learn from you.

    Personally, I also feel that many investment are getting expensive now, whether it’s property or stocks. I’m thinking of taking profit on my stocks including the REITs that I’m holding. However, it’s always a dilemma for me on when is the best time to sell. Cause if I sell them now, I’ll have excessive cash sitting in my bank account to earn pathetic interest rate. But if I wait and market correct, I’ll lose a lot in my capital, just like what happened in 2008. By the time when everything looks dirt cheap in 2009, I no longer have liquid cash to invest. Some of my portfolio that I kept since 2007 high are still bleeding and have never return to its previous high.

    • Hi Daniel, no problem.

      Yes, it is indeed a dilemma. Portfolio allocation is an art and there must always be a balance. Which means you do not have to sell everything and wait in cash, neither do you have to hold everything in stocks. Allocate a certain amount to cash to wait for opportunities. The hotter the market, the higher your cash allocation should be. With respect to how much to allocate, I can only advise you after meeting you and structuring a financial plan.

      There are certain stocks that are best cut off, even though they may not have gotten back to your purchase price as the earlier you do so, the earlier you can deploy the capital to better assets.

  5. Hi Calvin, sorry to sidetrack from the topic on 50-year loans but I have a burning question about property loans. With your years of experience in the property market, how do you view the risk of margin calls on properties in the case of a prolonged property market crash (i.e. broad-based drop in prices for a prolonged period of time e.g. 30-50% for 3-5 years). I understand that unlike stocks, margin calls rarely happen but it is still possible and perfectly legal for banks to perform a margin call if the valuation of the property is lower than the loan amount.

    From what I heard in the grapevine, many years ago, such a situation happened during the Asian Financial Crisis in 1997 until the SARS crisis in 2003. While such cases were not that widespread, there were enough of such cases to highlight this risk.

    Any opinions?

    • Hi Shaun, loan top ups for housing loans are definitely possible and it has happened to many people, including some of my relatives during the Asian Financial Crisis. When times are very bad, you will be surprised at how ruthless the banks are in withdrawing the support which they so rampantly throw out during the good times.

      This is why the government is being prudent in implementing the lower LTV ratios as the first to be hit are loans for investment properties versus loans for primary home residence. That is because the banks feel safer that since it is your own home, you will definitely try your best to pay for it. However, investment properties are a different story. It highlights the danger of not only overpaying for a property, but also refinancing properties that have appreciated in values. The equity in the property (i.e. value – loan amount) provides a cushion against loan topups, that’s why it is always important to watch your own leverage.

      • Hi Calvin, to the best of your knowledge, are all banks similarly ruthless when times are bad? Are there some banks with a notorious reputation to callously perform margin calls once property valuations fall below the loan amount and are there some banks who would take into the borrowers’ credit ratings? It doesn’t seem to make sense to enforce a loan top-up if the property owner has a stable job with an income more than sufficient to make monthly repayments despite the property valuation decrease. It isn’t uncommon that borrowers have sufficient cash flow to meet monthly mortgage payments, yet have insufficient lump-sum of cash lying around to meet a margin call. It would seem seriously ridiculous if the banks foreclosed on such borrowers … or is this worst-case scenario really unlikely to happen?

        • Hi Shaun, it depends on who is running their credit control policies at that point of time. People and organizations do change over time so looking at records which are more than 5 years old may not be indicative of what will happen in future.

          Know this, they don’t really care even if your unit is rented out and receiving income. If the value of the property falls below a certain threshold, it doesn’t have to be lower than your loan amount, then they have every right to ask you to top up. You can argue all you want, but they are your boss and they hold your title, if you don’t top up they can just auction off your house. Investment properties will be the first on the target list when the banks need to shore up capital. There is a risk in everything, so we can’t really say this scenario is unlikely to happen. Protect yourself by not over borrowing, increasing leverage to the maximum and make sure you have equity in the properties you buy. Zero down payment is a really bad idea with respect to this scenario.

  6. Winston Chiam says:

    4 years ago in 2008, I was in the US at the state of Arizona trying to understand the Sub-Prime Crisis. While I was there I watched Michelle Obama at the Rally and I was impressed by her speech.

    Today she speaks again, see link to the video:

    http://www.youtube.com/watch?feature=player_embedded&v=5HpbOrC5iEo#!

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