Mortgage serviceability: Reality versus Fantasy...

The following article contributed by Mr. Kuo How Nam appeared in the Forum page of our de facto English newspaper today.

Borrowers need reality check

THE key element determining a person's ability to pay his mortgage is income, whether it is from employment or from rent ("One in 10 borrowers overstretched, warns MAS"; Wednesday).

Rising interest rates can be managed if there is sufficient income, and if it grows in tandem with the rate increases.

Trouble begins if this does not happen. All it takes is for one spouse to be retrenched, or go through a period of unemployment, to spark a financial crisis in the household.

The same happens if properties are unoccupied or if rents do not cover mortgage payments.

There has not been much discussion on expected rental trends. This is an important element in determining debt-paying ability, as many people have bought additional properties on the assumption that the promised rental yields are better than the returns from alternative investments.

In many cases, they will be totally reliant on rental income for mortgage payments.

But we know that there is a huge supply of completed units coming on-stream in the next couple of years. Many are in the outlying areas, and several are shoebox units or tiny apartments.

These new locations and designs are, so far, untested in the rental market. There is the real possibility, particularly with slower growth in the labour force, that these new units will go unoccupied when they are completed.

Owners will be hard-pressed to meet their payments if this happens.

Property owners need to do a reality check and evaluate their vulnerabilities in the face of such uncertainties. They need to assess their employment and job security.

Nothing is worse than being unemployed and having outstanding mortgage loans.

They need to think of alternative scenarios, such as whether they can rent out their properties, the expected interest rate increases and how these will affect their cash flow.

Lastly, they must look at what cash reserves and resources they have available to ride out a rough patch that can last several years.

If necessary, they should lighten their debts, perhaps even taking a manageable loss now as a preventive step.

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There has been increasing sound bites recently from both government and financial institutions about rising interest rates and how this may affect homeowners with huge mortgages. This raises concerns that the low borrowing rate environment that we have grown so accustomed to for so long may be under threat.

The property buying euphoria has grown from strength to strength over the past 5 or so years, despite seven rounds of cooling measures. However, the latest (8th) sets of cooling measures may have bruised (the wife and I wouldn't exactly say "broken"...yet) the camel's back finally.

While it is natural for people to want to "get in" on a bull market, many have either failed or refused to acknowledge the fact that the property market actually go in cycles and those who are over-committed or highly-leveraged will be in trouble once the market starts to turn. One does not even have to be retrenched to spike a financial crisis at home - a combination of falling prices/rental returns and interest rate spike is sufficient to cause many sleepless nights (trust us, we have been on that road before). This is made worse if you have more than 1 mortgage to service.

Many will pour scorn on our cautionary tale even as recent as last quarter of this year, but the scenario doesn't seem as far-fetched today, given the double-whammy of a huge influx of new "for investment" apartments that are steadily coming on-stream and a much poorer rental climate.

There is this other thing that the wife and I cannot quite comprehend: whenever we spoke with people who need to "downgrade" from their current apartment due to financial constraints, the common notion is that they will be selling at a "loss" if the price they fetch is less than the price that they have bought the property for, say, 5 years ago. Few (actually NOBODY, that we have dealt with on the subject so far) will take into consideration the opportunity cost of occupancy - everyone expects to stay in their apartment "rent-free" and then made a killing off it when they want to sell. The usual "justification" is that if they cannot sell the apartment for higher than what they bought it for, they will be out of pocket and that makes any replacement purchase an even bigger challenge. We reckon this is the main reason for the big price gap seen buyers and sellers, especially during a bull market. But if the market is indeed turning, maybe sensibility will finally prevail and such disparity should become smaller? The wife and I certainly hope so.....