A home equity loan and cash-out refinancing, allows you to draw out the value of your house in cash without having to sell it. To many Singaporeans, one of the main drawbacks of property is that it locks down your cash. To start a business or send your children overseas to study, you may have to sell your house but by taking a home equity loan, you get to fulfil your obligations while keeping your home.
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What is a home equity loan (cash out refinancing)?
A home equity loan (sometimes also referred to as a term loan, reverse mortgage, or cash out refinancing) is a secured loan that uses your home equity as collateral.
Here’s a simple example: say you have a fully paid-up property, which you bought at $850,000. At present, however, its appreciated value is $1.2 million.
At this stage in your career, you have decided to quit your job and set up your own company. However, you don’t want to sell your house just to get the capital to do so.
Through a home equity loan, you can borrow up to 75 percent of the value of your house ($900,000) without having to sell it.
Your property is the collateral for this loan (it’s a secured loan), so the interest rate is extremely low—often around 1.6 percent per annum.
This gives you a large amount of capital to work with at a much lower interest rate than a business loan. Keep in mind that most business loans are upward of 6.5 percent per annum.
Now, you may notice that this feels very much like getting a mortgage for a second time. This is why a home equity loan or term loan is also sometimes called a reverse mortgage, or a second mortgage. But note that the interest rate— around two percent per annum — is still lower than a typical home loan rate.
How to use an equity loan for debt consolidation?
You may have heard of home equity loans being used as a form of debt consolidation. This is sometimes used as an alternative to selling the house to pay off debt.
For example: say you owe $100,000 in assorted credit card bills, personal loans, or other debts. You cannot easily repay such loans on your salary alone. However, you do have a paid-up house.
Instead of selling the house to pay off your debt, you may be able to take a home equity loan. You can use the term loan to borrow $100,000 — which is probably not even 10 percent of your home value — to pay off all the high-interest, unsecured debt at one go.
This would leave you with a single debt (the home equity loan), which has an interest rate of just 1.6 percent.
Of course, it’s best to speak to a qualified financial planner or debt counsellor before doing this. They’ll be able to advise you if a term loan is an appropriate solution for your circumstances.
How to calculate the equity loan amount for my property?
You can take out a home equity loan even if the property is not fully paid up. This is because the collateral is the paid-up portion of your home. However, you will have to subtract the outstanding loan amount from the maximum you can borrow.
General formula for calculating the amount of equity loan from your property without any CPF usage:
(75% x (Market Value of Property)) – Outstanding Mortgage Amount = Equity Loan Amount
Let’s say, for example, that your home has a value of $1.2 million. You still have an outstanding home loan of $500,000 on the property. Your total home equity loan could be: (75% of $1.2 million) – $500,000 = $400,000
However, the drawback to this is that you would still need to meet the Total Debt Servicing Ratio (TDSR) restrictions; see below for more on this. You would then be servicing two loans — your outstanding home loan and the home equity loan.
In addition, you must take the home equity loan from the same bank that you got your home loan from. Your home cannot be used as collateral for two different lenders!
If for some reason your bank won’t approve the home equity loan, you’re stuck until you’re done paying off your mortgage. Alternatively, you can speak to a home loan specialist and see if they can help push your home equity loan approval.
Does CPF usage affect my equity loan amount?
When you take out a home equity loan, the maximum amount is reduced by the Central Provident Fund (CPF) monies you used to purchase the house.
For example, if you have used $200,000 from your CPF to make your down payment or to service home loan payments, your total home equity loan amount will be reduced by $200,000.
This is to prevent you from withdrawing your CPF money in a roundabout way. As such, anyone intending to use a home equity loan should consider sticking to cash when servicing the home loan.
Also, you cannot make home equity loan repayments with your CPF. The loan repayments must always be in cash.
Common restrictions on home equity loans
A home equity loan can only be taken on a private property. If you own an Executive Condominium (EC), you can take a home equity loan only if you have passed the five-year Minimum Occupancy Period (MOP).
In addition, there are three other factors to consider:
First, there is still the TDSR to account for.
As with a regular home loan, your total monthly debt repayments — after taking the home equity loan — cannot exceed 60 percent of your monthly income.
However, an exception to this is if (1) your property is fully paid-up, and (2) you are borrowing no more than 50 percent of the property value, you don’t need to meet the TDSR requirements.
Second, there is a restriction on the maximum loan tenure of a home equity loan.
This is either 35 years or until the borrower reaches the age of 75, whichever period is shorter.
Third, you are not supposed to buy another house through a home equity loan.
Officially, the Monetary Authority of Singapore does not allow you to use home equity loans as a way to gain funds for another house. However, there are situations where borrowers have used a home equity loan to pay off a second, outstanding housing loan.
For example, say you have a fully paid-up house valued at $1 million, and a small investment property (a shoebox you just purchased) at $850,000. There is still an outstanding loan of $250,000 on the shoebox unit, at an interest rate of 2.2 percent.
You could take a home equity loan on your paid-up house at 1.6 percent, then pay off the outstanding loan on the shoebox unit. This process can incur various legal fees and charges, so be sure to consult a home loans mortgage broker before undertaking this.
You are not, however, supposed take a home equity loan to add another property to your portfolio.
Fees and costs for a equity loan
Legal fees for the paperwork on a home equity loan typically cost $2,500 to $3,000. In addition, some banks may impose added charges. For example, a bank may want you to pay valuation fees on your house to check the appreciated value.
In addition to the legal fees, there is a wait time of about two to four months after application approval before the bank provides you with the funds. So if the cash could be needed urgently, start the loan application process early.
Note that you will have to go through this process each time you want to take a home equity loan. As such, make sure you borrow what you need the first time around. If you decide to borrow more later, it will mean paying legal fees again and another two to four months’ wait.
Key things to beware of with home equity loans
The most important thing to bear in mind when taking out a home equity loan or term loan is that your home is used as collateral. The bank has a right to foreclose on your house if you cannot make repayments.
As such, a home equity loan should not be taken lightly. Never abuse it by using the money for recreational or luxury purposes, such as buying a sports car.
Second, retirees should remember that their CPF money cannot be used for term loans. Home equity loans must be paid in cash.
For example, say your children ask you to take out a home equity loan to help them fund their start-up venture. They promise to make the loan repayments for you. Before you agree, make sure you have a back-up plan should they fail to do so. After all, you are the one who may lose a home.
A home equity loan can be a powerful financial tool to unlock the value of your house
It is one of the few ways to get cash out of your property without having to sell it or rent out rooms. Also, it provides a very high loan quantum at some of the possible. It is, in fact, one of the key advantages of owning a private property instead of an HDB flat.
However, home equity loans should be used with care and under advisement. Consult both home loan specialists and financial planners to determine if it’s the right solution for you.
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