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Friday, 26 November 2010

Subprime Crisis, Singapore's version?

The Year 2006

A few years ago, my wife and I are the 'fortunate' few to buy left over HDB flats under the walk-in scheme. As the flat came in standard condition, i.e. totally bare, we visited a few condominium showflat for renovation ideas. My wife was tasked to absorb as many ideas as possible while I entertain the agents as a prospective buyer. That was when I started to pay attention to the loan, interest rate etc.

Most mass market private property then was going around $600,000 for a 3 bedder of equivalent size to a 5 room HDB. Based on our combined income, the maximum loan the bank would grant us is sufficient to service the maximum 90% valuation of the property, as allowed then.

The Year 2010

With the economy out of recession with an expected double digit GDP growth for the full year, demand for private property surged strongly and continued to do so even with recent cooling measures. I am thus curious to find out more, especially from the perspective of not so deep pocket buyers on the street. We went to the Spottiswoode Residences near Tanjong Pagar to take a look. After the usual tour led by the agent, we found ourselves talking to a banker (I never met one in 2006) to assess our financial capability. My eye almost pop out when he worked out the maximum loan the bank will grant us. No, our combine income never shoot the roof. Though our income did increase, but definitely far far below the 300% jump in maximum loan allowed, in just 4 years. It never take too long to realise the key difference, 1.5% effective interest rate (not the initial year promotion interest rate). That's 40% lower than HDB's concession interest rate of 2.6%!! I can't remember what's the effective interest rate in 2006, but definitely higher than 2.6%. Using 50% of disposable income as a guide for maximum installment potential a month, no wonder we can take on such a huge loan!

Made in USA

First they lower their key interest rate to nearly zero, then they print money, then they printed some more. The net effect is the ultra low interest rate environment property buyers are 'enjoying' at the moment. Let's assume a typical couple with pockets of reasonable depth decided to buy a private property. Even if they are not crazy enough to take on the maximum loan that will shave off half their monthly income, they would still be forking out much higher monthly installments as they would like when the interest rate eventually recover to a more reasonable figure of 3-4%.

Potential Problem(s)

For the best case scenario, the interest rate raises to the 3-4% eventually and these genuine non-deep pocket buyer-stayers are able to folk out the higher monthly installments. A worse scenario would be the eventual burst of the property bubble and valuation drops below the outstanding loan. Bank theoretically can only loan up to 70% of valuation, so if valuation drops, they can lend less, and the buyer has to pay up the difference. But according to the Banker, so long as the buyer promptly pay up the installments, banks don't normally execute such 'margin calls'. The worst case scenario would be the burst of the property bubble coinciding with the next recession. i.e. drop in property value and loss of income.


From the buyer's perspective, the risk is personal. But from the banks' perspective, it seems to me that even the maximum 70% valuation limit on the loan is not quite sufficient to limit the number and amount of potential bad loan if the unreasonably low interest rate is used to justify the maximum loan allowed in a growing property bubble.

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