A home equity loan allows you to borrow money at favourable rates by using your home (or at least the portion you already paid up) as collateral.
Unlike other types of loans where the bank pays the developer, renovation contractor or school directly, in the case of home equity loans, you literally get handed a bunch of cash. Thus, home equity loans are also referred to as “second mortgages” or “cash out refinancing”.
Here’s what you need to know about home equity loans and the considerations you need to have before taking one.
How A Home Equity Loan Works
Theoretically, the maximum amount you can borrow with a home equity loan is 75% of your home value or the formula below, whichever is lesser:
Property Value – Outstanding Loan Amount – CPF Monies Used
By not allowing you to borrow more than 75% of your property value, banks have a buffer against your property value dropping below amount they loaned you.
For the CPF monies portion, banks typically also project your CPF usage a few months into the future, with accrued interest, bringing your total eligible loan amount even lower.
The maximum tenure you can stretch your home equity loan is 35 years or up to the borrower’s age of 75, whichever is shorter.
One more consideration when planning your loan amount and tenure is that under revised rules, the Total Debt Servicing Ratio (TDSR) would apply only if you’re borrowing more than 50% of your property’s value.
Who Is Eligible To Take A Home Equity Loan?
In Singapore, borrowers must be owners of a private property, as well as HDB Executive Condominiums after fulfilling the Minimum Occupation Period of 5 years. HDB owners are not eligible for home equity loans.
For home owners who still have an outstanding home loan, you must get your home equity loan from the same bank.
Uses of Home Equity Loans
The benefits of home equity loans for borrowers are obvious. First, it gives you cold-hard cash at the same low interest rates that you enjoy with home loans. Second, the amount of money you can borrow is higher, provided you paid up most of your private property. In contrast, other kinds of loans might only lend you a multiplier of your current salary.
This makes home equity loans useful for a range of uses, including paying off higher interest debts, starting a business, helping your children with their education, or as an alternative to financing a car or renovation expenses.
In theory, MAS does not allow the use of home equity loan for the purchase of another property (either for yourself or for your children), though in practice, it seems like it is not an uncommon practice.
What You Should Note Before Applying For A Home Equity Loan
When receiving large wads of cash, you must not forget that you’re taking on additional debt that must be repaid. The interest, while low, is still interest. This means that unless you are doing something to grow your money, you’ll be paying more for the cash today over the long run.
Thus, potential borrowers must do proper analysis about how much money they need, how long do they need it, and how much in total they will end up paying. Many things can happen over the next 5 years and beyond. You might lose your job, the property market might be in another slump, or you might have unexpected healthcare expenses.
Ensure you have the right insurance policies and contingency plans to protect yourself financially in the event the worst happens.
Similar to home loans, home equity loans require valuation and legal fees, which can be in the region of $2,500 and more, depending on the property type. You need to factor that into your cost of borrowing, alongside interest.
Unlike home loans, you cannot use your CPF to service your home equity loan repayments. So this means that you need to have sufficient cashflow each month to take care of your home equity loan repayments.
It goes without saying that missing payments can have disastrous consequences, such as your home being repossessed by the bank and you needing to declare bankruptcy.
If You Plan To Get A Home Equity Loan
If taking a home equity loan sounds complicated, well, in a way it is. There are many rules and considerations that borrowers need to be aware of. In addition, comparing the fine print from multiple banks’ loan packages is probably not something you want to spend your time doing.
To help guide you through the process and get you the best home equity loan – or any home loan, for that matter – you can approach our friends at Redbrick.
Simply fill in the contact form and an experienced Redbrick mortgage specialist will be in touch with you for a non-obligatory consultation. The best part? Their services are free for you, since its the banks that are footing the bill.