Are You Stuck in Property?

Rising property prices have become a hot topic and many investors have jumped into the property market lately amid the present of many cooling measures introduced by the authorities. It is common that many people keep large amount of their money in savings accounts or fixed deposits and refuse to take any kind of risk with it even for the low-risk fixed income type of investments. Yet, once the opportunity to buy a property turns up during a property boom, they quickly take out all that money and place it on the initial down payment for the property.

Buying property as an investment involves risk just like every other investment. In fact, most people have to take up a mortgage loan to buy property. With the rise in property prices over the years, there are many investors who are committing well over 30% of their income towards property. People max out the loan amount, and saddle themselves with huge monthly housing loan installments in their desire to buy property.

This is risky as a huge property loan is also a loan on all of our future income. Other than the upfront down payment, you will also be paying big sums to service the loan every month once you choose to buy as expensive a property as you can afford.

It is very risky to make a bet on our future income, in a pursuit to own a big house. All it takes is just a change of job or a layoff, for our income to change accordingly as well. But bank will never care if your income happens to shrink, they will just repossess your house if you can’t service the loan! Unless you are absolutely sure that your job and future income is very much secured, otherwise, it is not advisable to use most of your income towards paying off your housing loan.

So how much should you commit when you want to buy a property?

Safe borrowing reduces risk (30-60 Rule)

Despite your desire to own property, it is important to do your sums first. As a rule of thumb, we always recommend home buyers pay no more than 30% of their current household income in mortgage repayments of their home.

For example, if the total monthly income of a young couple is RM4000, they should only spend RM1200 or less on monthly installment for their new home. Assuming that effective interest rate of housing loan is 4.5% and they are entitled to loan up to 30 years, RM1200 should be enough for them to service a loan amount of RM238,500^[1]. If they use that loan amount for 90% of a new property, say an apartment, then they should be able to buy an apartment worth RM265,000.

As for property investors who invest in their second property onwards, they should keep the monthly installment of each property below 60% of the monthly income that the property is generating, such as monthly rental income of the property. This is to provide some room to maintain a positive cash flow should banks revise interest rate to even double of the existing rate.

For example, if the same young couple in the previous example, wants to invest in a rental apartment costs RM265,000 using the same loan package, they must be sure that the apartment is able to rent for at least RM2000 per month, so that 60% of the monthly rental income is enough to cover the RM1200 monthly installment.

In the second example, if the interest rate doubled from 4.5% to an awesome 9%, then the monthly installment will increase from RM1200 to around RM1900. Here you can see that the increased monthly installment is still below the monthly rent of RM2000, although interest rate has doubled. This buffer is more than enough to serve as a safety net against an interest hike.

We ourselves call this the 30-60 Rule of Property Financing.

• Pay no more than 30% of your current household income for mortgage of your home.
• Installment for investment property should be less than 60% of the income generated by the property.

What if you have done your sums, realise that you can’t quite start off with that dream home immediately, but you really want to invest your money in property? There are many other investment options which don’t quite require “all bets on the table”. You can buy property stocks, REITs, or property unit trusts, all of which can give you exposure to the property market without having to bet everything on just property alone and you can do it without having to take up a loan.

What to do if you are already stuck?

Many home buyers are feeling financially overstretched after under-estimating all the costs that being a homeowner brings. Most of the home buyers also found the additional expenses associated with buying a home on top of their mortgage payments had been more than they had expected. The huge expenses related to property ownership make these owners realise that they are already stuck in a financially overstretched situation.

When you overstretched and put yourselves in an awkward situation like this, you may be reluctant to let anybody know, even your closest friends and family. So how can you improve your financial situation if you are already overstretched financially?

1) Shed those personal and outstanding debts.

This is definitely the first thing you must do. Remember, those interest rates do nothing to help your situation. The last thing you want to happen is to see them climbing and making your situation much worse than it already is.

The important thing to do here is to be proactive. Do not sit around hoping that your financial situation will improve on its own. Cancel subscriptions that you do not need, gym membership, premium TV channels or magazines can wait till your situation improves. Use this money to lower your debts.

2) Downscale property.

Yes, it is definitely time to take a step back and try to live on less. This means getting rid of everything that you do not need but only serves to complicate your life and your bills! This would be a good time to scout around your house and getting rid of anything that you have simply stopped using.

Old gym equipment, old clothes or even your bike can be written off for sale. Imagine the amount of money you can make from stuff that you have absolutely no use for. Do a full sweep and be ruthless. Now is not the time to be sentimental.

3) Get a lodger or tenant for spare rooms.

This is an excellent way to make money on the side while not actively doing anything. This will help you take care of your utility bills and other financial needs. Taking in a lodger can also mean added security for your home provided it is somebody you can trust, for all the time that you are away. There are no statutory rules involving lodgers as well so if your lodger proves to be unsuitable, you will have an easier time removing him from your premises.

4) Live with parents or friends.

Before you balk at the idea, remember, this is just a temporary set-up only if you really have no choice but to sell the property that brings you into such situation. A few months is all you need to get back on your feet. Explain to your parents/friends that this is only temporary and if they understand enough, they should not have any reason not to let you stay for awhile.

Just remember to return the favour and not sit your butt all day. Do the dishes, wash the car, water the plants and be helpful. When the time comes that you are making enough money on your own again, graciously say thank you and start looking for your own place again. Do not overstay your welcome.

5) Speak with bankers.

In many cases, bank is the last one who wants to see your property goes into foreclosure. Especially when the cost of foreclosing will be greater than what will be recovered, then it’s not worth the time, effort, and expense to foreclose a property. Of course, each individual bank has their standard procedures to follow, but you can always try to speak to them and see if there is any possible way to restructure your loan so that your monthly commitment can be lowered.

Possible means are like refinancing for lower interest rate or longer tenure, or converting the existing loan to an interest only loan. For example, these days some banks provide customers the flexibility to service interest payments only for the first few years. Ask around a few banks other than your existing lender to find out which one is able to help you.

Prevention is better than cure

There are many costs you don’t have as a renter which materialise when you buy a house. These include insurance, loan repayment and maintenance costs. Hence, before borrowing for a house you must ask yourselves if it is affordable. You must ask if your future employment is stable.

If you’re planning on having children, will one partner give up work, or will there be childcare costs that affect the capacity to service a loan. Most young people assume their capacity to service debt will increase with age, but that isn’t always the case. Having children is one classic example of a huge increase in expenditure that has to be budgeted for.

In summary, to prevent yourselves being overstretched financially in property, always ask yourselves the following 10 questions before signing up for a home loan:

1. Is your industry stable?

2. Is your job stable/how easy is it to find similarly paid employment?

3. What percentage of your income will be spent on the loan?

4. Have you factored in the cost of loan, insurance and maintenance?

5. Are you factoring bonuses and commission into the equation?

6. Will you have children?

7. If you have a joint income, is your partner likely to take time off to look after children?

8. Will you send your children to private school/university?

9. How important is your current lifestyle to you?

10. Could you change your lifestyle in order to repay a big mortgage loan?

The desire to own property is strong everywhere, and this trend is likely to continue. The rise in property prices over the years has made many people jump into the property market in search of gains. But property investment is by no means risk free. In fact, due to the leveraged nature of having to take on housing loans to buy property, investing in property can result in huge capital loss if the property market goes south. There are still some properties bought at the height of the previous property highs in 1990s which are now only barely breaking even or still underwater.

The one and only one deadly ecstasy that catches a huge population of financially overstretched people is greed. While the potential for capital gain is there, we have to resist the temptation to buy as big a house as we can and always do our sums and checks first. As with all other types of investment, be prudence and do not overstretch yourselves in property, even if you can already see a big carrot in front of you.

^[1] All of the computation involved in this article was performed using GoFinance™. GoFinance™ is a proprietary investment analytical tool available only to members of www.propertymethod.com.

This article was co-written by KCLau of KCLau.com, published in October 2014 issue of Property Insight magazine as “Are You Financially Overstretched in Property?”, and published in 24th June 2015 issue of 1Klassifieds, New Straits Times.