How does MAS's New Debt Servicing Framework Affect You?

MAS's new debt servicing framework essentially stipulates the minimum standards of how financial institutions calculate the Total Debt Servicing Ratio (TDSR) and plugs loopholes that existed previously. Here's a summary of the key details.

• TDSR to be computed based on an interest rate of 3.5%.
  • Previously, the rate that each financial institution used can be quite different. For example, Bank of China used their prevailing housing loan rate, which is below 1.5% for the longest time, while a couple of banks based their TDSR computation on interest rates of more than 4%.
   
• TDSR to be computed based on the income-weighted average age of the borrowers.
  • Most banks used to take the average age of borrowers without factoring in any income difference between the borrowers. Others, like OCBC, simply compute the TDSR based on the younger borrower's age.
   
• A haircut of at least 30% to be applied to all variable income (e.g. commissions, bonuses) and rental income.
  • All financial institutions did not apply any haircut on bonuses while the majority apply a 30% haircut on commissions and rental income.
   
• TDSR threshold should not exceed 60%.
  • Most financial institutions' TDSR threshold is 50%. A couple of banks allowed a TDSR threshold of 60% if borrowers met certain criteria.
   
• Borrowers must now be be mortgagors
  • Unlike HDB housing loans, private property loans did not use to have this restriction.
   
• Guarantors for borrowers who do not meet the TDSR threshold must now be brought in as co-borrowers
  • The housing loan that a guarantor is supporting does not contribute towards his or her housing loan quota (2^nd property loan financing is currently at a loan-to-value of 50% or lower).

How does this MAS framework affect the man in the street?

• For single borrowers or joint borrowers around the same age, they can now borrow slightly less than they could have, assuming these folks know where to look previously. Those who do not know or care to find the bank offering the highest loan may actually obtain a marginally higher housing loan than before.

The new framework impacts the following groups of borrowers most.

• Joint borrowers where a big age gap exists between the borrowers, and the older borrower is earning significantly more than the younger borrower (e.g. father and son)
• Self-employed
• Commission earners like insurance and real estate agents
• Employees where around 35% or more of their annual pay is derived from bonuses

The Best Kind of Loan

Personal loans of any kind are traditionally frowned upon, especially by the Chinese. It suggests financial recklessness, lack of discipline and sheer laziness. Even though the financial sector and its loan offerings are nothing like the scene decades ago, many of us still adopt the same mindset as our forefathers. In fact, I had such a tough time shifting the paradigm of two of my close friends that I'm inspired to pen this down.

Being financially prudent is fantastic but financial prudence and loans are not contradictory. Not all loans are bad. I would even go so far as to say that there is a great kind of loan and at this point in time, not maximising it may in fact be financially imprudent. What is this loan I'm talking about? A housing loan. There is a confluence of factors that make a home loan a winning proposition: persistently low mortgage interest rates coupled with relatively high inflation and CPF interest rate.

Low Interest Rate
There is no other type of loan that has a lower interest rate than housing loans. Period.

Not only is the stated interest rate lower than the other types of loans, its amortization methodology is also on a daily or monthly rest basis, making its effective interest rate much lower than the rest. Unlike the monthly interest payment for your car loan, which is computed based on the initial sum borrowed, the monthly interest for your housing loan is computed based on the outstanding balance as of the day (daily rest) or month (monthly rest) of your payment.

Relatively High Inflation
When inflation is higher than the interest rate for your loan, after setting aside your rainy-day stash, it's more sensible to either spend the money or invest it. Why save the money and see your purchasing power dwindle? Only if you do not have anywhere to spend or invest, does it make sense for you to pay down your housing loan.

Relatively High CPF Interest Rate
When the CPF interest rate is generating a higher interest than my housing loan interest, even though I cannot withdraw my CPF monies, I still prefer to keep money in CPF rather than use it to pay off my loan. If I use money from the Ordinary Account to pay down my home loan, not only will I be losing out on the difference between the CPF interest and the housing loan interest, I will also have to pay back from my own pocket the CPF accrued interest if I subsequently sell my property. This is like borrowing money from my own CPF to pay off a lower interest rate loan! There is no hurry to tap on CPF funds as I can always pay down my housing loan subsequently, when my housing loan interest rate goes higher than the CPF interest rate.

As of February 2013,

• Housing loan interest rates are around 1.1% onwards
• Consumer Price Index (CPI) is 4.9%
• MAS Core Inflation Measure (basically CPI excluding property and private transportation) is 1.9%
• CPF interest rate is 2.5% or 3.5% (for the first $60,000 of a member’s combined balances, with up to $20,000 from the OA)