Housing loan defaults

IT is better to invest in property than buy a car, which depreciates in value. One should also spend within one’s means. What’s often unsaid in these old adages is that one should only borrow what one can comfortably repay, even when it comes to “productive debt” for an appreciating asset.

Defaults on housing loans, for instance, were the top cause of bankruptcies in Malaysia in 2012. The 5,341 cases made up 27.3% of the total of 19,575 bankruptcy cases that year, which means 15 people were going bankrupt every day that year for not being able to service their housing loan.

Bankruptcy cases resulting from housing loan defaults were the second highest after car loan defaults for 2010, 2011 and 2013, data from the Malaysia Department of Insolvency shows. Instances of housing loan defaults declined in 2014 and 2015 but continued to be the third highest cause of bankruptcy after car loan and personal loan defaults. Seven people were going bankrupt every day from not being able to service their housing loans in 2015.

The rise in housing loan defaults could well be caused by people taking multiple loans for speculative activities that drove home prices above the RM165,060 level (three times the median household annual income in 2014) defined as affordable for most Malaysians and made cooling measures necessary.

Recall that a 70% loan-to-value (LTV) cap was imposed for the third and subsequent mortgages in 2010 after the Real Property Gains Tax (RPGT) was reintroduced at 5% for properties sold within five years. By 2013, the RPGT was 15% for properties sold within two years and 10% for those sold within three to five years. Now, the RPGT is 30% within three years, 20% within the fourth year and 15% for the fifth year.

It was also in 2013 that Bank Negara Malaysia capped the maximum mortgage tenure to 35 years — a move it stood by last September as it said the main problem confronting potential buyers of affordable houses is a shortage of reasonably priced houses and not access to financing.

The central bank, in the statement on Sept 20, 2016, reiterated that its responsible financing guidelines are in place to “prevent borrowers from falling into financial hardship due to excessive debt burden that may lead to foreclosures which will undermine the objective of house ownership”.

That is partly why Bank Negara wants financial institutions to measure one’s debt servicing capacity using net income rather than gross income so that borrowers can meet debt repayments with sufficient buffers for living expenses as well as future increases in financing rates and rising costs.

Yet the Special 1Malaysia People’s Housing Programme (PR1MA) End Financing (SPEF) scheme essentially allows PR1MA homebuyers to borrow more money than they would otherwise be able to do via a conventional loan. It also assumes a higher debt service ratio of 70% versus up to 60% for a conventional loan.

The SPEF “step-up” is with the aid of his or her Employees Provident Fund (EPF) Account 2 savings (30% of statutory deductions for retirement) plus a higher than conventional interest cost.

“It is important that lending institutions are comfortable with the ability of the applicants to service the loan given that the debt service ratio is also raised. Banks will have to set aside a higher buffer for the potential rise in loan delinquencies. As in risk-based pricing system, the higher interest rate charged is one form of protection for the lenders,” says Yeah Kim Leng, economics professor at Sunway University Business School.

Estimated loan eligibility

When releasing details on Feb 13, PR1MA CEO Datuk Abdul Mutalib Alias told reporters that banks are more “comfortable” with the new moratorium of sale on PR1MA houses of five years versus 10 years before.

Under SPEF, monthly loan commitments are lower for the first five years when only interest is charged, with principal payments only kicking in on the sixth year.

Abdul Mutalib said borrowers would be forced to reprioritise their spending habits to be able to make the higher repayment when the principal payments start in the sixth year. The assumption here is that the borrower’s income would also be higher by the sixth year and he or she would have also reduced other debt obligations to be able to service a higher monthly mortgage repayment obligation.

Yeah, who was formerly RAM Holdings group chief economist, agrees: “From a national perspective, the higher overall credit risk is counter-balanced by the greater financial discipline that the PR1MA SPEF scheme will impose on borrowers. This is akin to forced savings for young working adults, especially those who choose to sacrifice present consumption for future comfort.”

Still, the fact that PR1MA’s CEO said 60% of its buyers could not get conventional loans means there is a lot riding on the borrowers becoming more disciplined.

“SPEF definitely has a higher risk profile. The long-term trend of rising house prices and stable employment and income growth are basic assumptions of the ‘normal’ scenario for lenders and borrowers. There is a built-in assumption that the purchaser’s income will rise faster than inflation so that when the principal payment kicks in, the debt service ratio comes down or remains unchanged. Obviously, if the borrower loses his or her job, there will be a default,” adds Yeah, who reckons that PR1MA may need to think of an employment insurance scheme for SPEF borrowers.

Paying interest only in the first five years adds to costs for the borrower as the interest on a home mortgage is calculated on a reducing balance.

Based on sample loan eligibility and monthly repayment data provided by PR1MA, someone earning RM3,000 a month would only be eligible for a conventional loan of RM180,000. Under SPEF’s stepped-up financing, however, the person would be eligible for a loan of up to RM283,200 when his or her EPF account 2 savings are taken into consideration for monthly repayments.

The SPEF borrower would have to pay RM1,096 a month interest for the first five years and RM1,615 a month from the sixth year for that RM283,200 stepped-up loan, according to PR1MA’s presentation slides. That implies the need for income to rise to at least RM3,500 to RM4,000 levels by year six plus a reduction in other loan commitments, or having even less disposable income, back-of-the envelope calculations show.

Based on a RM1,096 monthly interest-only obligation for the first five years and RM1,615 repayment a month from the sixth year on the RM283,200 loan, the implied interest cost is 4.64% per annum (Year 1 to 5) and 5.54% per annum (Year 6 to 35).

That works out to an interest cost of RM363,993 and total loan cost of RM647,193. The latter is enough to pay 67 years of rent at RM800 a month with RM200 a month to spare in the initial five years and RM400 a month to spare for the remaining 30 years — that’s a RM167,160 difference with SPEF monthly obligations over 35 years. The RM647,193 total loan cost is enough for 54 years of rent at RM1,200 a month.

To be sure, there is no guarantee rent will stay at RM800 a month but having savings for retirement and contingencies should not be neglected as one becomes a homebuyer.

The EPF, for one, encourages its members to “seek advice from its Retirement Advisory Services to assist in making an informed decision” before committing to the SPEF facility. Among other things, members “must be aware that upon choosing this [SPEF] facility, all other pre-retirement withdrawals under Account 2, namely medical, education, Age 50 and Haj withdrawals, will no longer be available until full settlement of the PR1MA loan,” the EPF said in an Oct 21, 2016 statement.

PR1MA's sample

Yeah also advises prospective SPEF takers to do their homework before taking any debt obligation: “SPEF takers should explore the best financing option that they can safely commit. They should be very clear in their ability to adjust their saving and spending pattern accordingly. Otherwise, they could be in financial ruin or suffer losses if they default. They should also take into consideration whether delaying home purchase and accumulating sufficient savings for a higher down payment and lower servicing burden may be a better long-term option.”

PR1MA’s four local bank partners for SPEF are Malayan Banking Bhd, CIMB Group Holdings Bhd, RHB Bank Bhd and AMMB Holdings Bhd.

“Bank Negara expects participating financial institutions to continue to observe responsible financing practices in assessing the applicants’ capacity to meet their repayment obligations throughout the loan tenure. This includes an assessment of future repayment capacity when repayments adjust (for example, after the first five years of fixed interest payments), taking into account future income earning prospects,” a central bank spokesperson tells The Edge.

Describing PR1MA’s special financing scheme as one that aims to assist eligible first-time homebuyers with strong prospects for future income growth, such as young graduates who have just entered the workforce, the spokesperson added: “PR1MA applicants will also receive financial education and counselling on financial management and retirement planning prior to loan approval. This is to promote prudent financial management practices among these applicants. These conditions will serve to mitigate rising non-performing loans.”

This article first appeared in The Edge Malaysia on Feb 20, 2017.

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