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27 Sep 2021
SOURCE: CPF Board
Nowadays, smartphones are commonplace. Look around while in a train or bus, and you’ll see many of your fellow commuters entranced by their touchscreens. Look a little closer, however, and you are likely to notice something else: not everyone is using the latest smartphone. Some might even be using models that are two or three generations out of date. Why is that? It’s not as if the newer models are sold out. Well, the answer is rather simple: sometimes, prudence takes precedence over the allure of upgrading to what may seem bigger and better.
This consideration certainly applies to property purchases, especially given that resale prices have been rising over the past few quarters. While it is undoubtedly important to have a roof over our heads, being prudent in one’s decisions to upgrade one’s housing is essential, given the scale of the financial commitment required. Upgrading your house to a bigger property that you cannot reasonably afford can set you back in the long run, leading to difficulties in servicing the housing loan – particularly in times of economic uncertainty or in the face of unexpected medical expenses.
Here’s an illustration, based on facts adapted from a true case.
Meet Mdm Lee, a single parent of two school-going children in her late forties.
Back in 2006, Mdm Lee had purchased a 3-room flat for about $160,000. With a take home salary of $1,800 and monthly expenses of about $1,300, which includes utility and handphone bills, grocery and children allowances etc, Mdm Lee could still manage her expenses. She was paying her housing instalment of $390 entirely with her CPF savings and saving some of her much-needed income for a rainy day.
However, her financial situation took a hit in 2011, when Mdm Lee decided to upgrade to a 4-room flat for about $450,000 after selling her 3-room flat for about $350,000. At the point of purchasing her current 4-room flat, Mdm Lee was earning a monthly income of $2,400, meaning the new flat cost about 15 times her annual salary at the time. In addition, the new housing loan - about $1,000 a month – now required her to pay $400 of it in cash every month, further cutting into her already strained income.
On top of the increased housing loan, Mdm Lee’s expenses in other areas also increased over the years. Now, both of her children are schooling and the education expenses are much greater as a result. In total, her current monthly commitments came up to about 95% of her take-home pay, leaving her with hardly any funds for miscellaneous expenses and emergencies, much less her own retirement.
So, when one of her sons required an unexpected surgery, Mdm Lee was instantly in a bind.
Based on Mdm Lee’s financial circumstances, there are three clear indications that she could not afford the 4-room flat.
1. The cost of the flat is fifteen times her annual salary.
Your annual salary is a good indicator of how much you can spend on your house. Realistically, the average price range of flats should be about four to five times your annual salary. Of course, if you have other commitments that require you to set aside a portion of your salary, it is advisable to consider even cheaper options.
2. Having a high Mortgage Servicing Ratio of 40%.
The Mortgage Servicing Ratio (MSR) is a rule that applies to loans for HDB flats and Executive Condominiums. It is put in place to help ensure that one does not strain one’s finances too much when buying a house. Currently, it limits monthly repayments to 30% of the borrower’s gross monthly income. In Mdm Lee’s case, she has over-stretched her finances with a MSR of about 40%, which was the MSR limit back when she purchased her new flat, but is nonetheless too high for her - especially when she has to take care of her two sons by herself.
To put it in simple terms: consider how much of your monthly salary you can set aside versus the monthly loans you would incur from buying a house. If you can comfortably afford the loans without compromising on your day-to-day expenses or savings, you’re good to go!
3. Her monthly housing deduction from Ordinary Account is more than her contributions.
Two-thirds of Mdm Lee’s monthly instalment is paid using her Ordinary Account (OA) savings while the remaining is paid using cash. However, her monthly OA contribution is $250 less than the amount that she is using from her OA. With her current OA balance of $2,300, Mdm Lee will eventually face greater difficulties servicing the monthly instalment nine months down the road. This fact alone makes it apparent that overstretching one’s finances in the way Mdm Lee did is simply not sustainable in the long run. When it comes to making big purchases such as this, it is advisable to plan ahead such that you can still maintain a healthy OA contribution so you can stay covered in case of emergencies, or simply for your retirement.
Had Mdm Lee decided not to upgrade to her current house, she would not have put herself under such financial strain. Had she weighed her current financial status carefully against the surge in expenditure incurred by upgrading her home, she would have been able to set aside a higher proportion of her gross income for other expenses.
With various factors at play – both foreseen and unforeseen – Mdm Lee’s case clearly underscores the importance of careful planning and ensuring one is financially able to accommodate a purchase decision as significant as upgrading one’s house. A hasty or uninformed decision can easily affect your finances not just in the short-term, but also in the long-term. In the worst-case scenario, it can even affect your retirement adequacy, thereby preventing you from achieving your desired lifestyle in your golden years.
To help further illustrate this case study, we have also prepared an informative video for you, available on our very own YouTube channel:
To ensure that you are making your housing decisions wisely, do utilise the tools available to you, such as the CPF Housing Usage Calculator. This will ensure that your wonderful abode will always be a source of joy for you and your family, and never a cause for worry.