An equity loan lets you borrow against the equity in your property, but careless use can have gnarly unintended consequences. Here’s what you should know about equity loans, and things to consider before getting one.
Did you know that the average Singaporean is ranked 12th globally in terms of mean net worth? That’s above Canada, France and the U.K.
But if that’s true, why aren’t you and I whipping out our money shooters to make it rain every time we go out for bubble tea with all the toppings?
Well, the likely reason for this saddest of disconnects is because rather than being cash-rich, most Singaporeans are asset-rich. That means that instead of having loads of cash sitting around in the bank, most of our wealth is tied up in assets, most likely property.
So what happens if you, say, need cash for your retirement, but all you have is the condo you’re staying in? You’d have no choice but to sell it, right? Because otherwise you can’t convert your private unit into cash.
Or can you?
What is an equity loan and who is it for?
You already know the answer — yes, you can, and the way to do it is with an equity loan.
An equity loan (sometimes known as a reverse mortgage) is a form of secured loan that makes use of your residential property. It allows you to unlock the value of your home to meet your financial needs without having to sell or lose your property.
How it works is that you pledge your property to the bank, in exchange for the loan. Because your property is put up as collateral, this makes equity loans different from unsecured loans, such as personal loans.
For one, the amount you can borrow is far higher in comparison, often close to the value of your property. But this is reduced by the amount still outstanding on your mortgage, if any.
For another, the tenure of the loan is much longer, up to 30 years in some cases.
And for a third difference, equity loans have much lower interest rates — you probably won’t run away and leave your home behind.
Now, to address who equity loans are for.
Well, you’ll first need to own a residential property. This can be fully or partially paid up.
And, the property should be a private development; you cannot take out an equity loan on HDB flats. (However, there’s the Lease Buyback Scheme, which might be suitable for HDB flat owners).
Given the above, equity loans are only available to those who own a private property, and who require a substantial amount of cash that may be difficult or expensive to get from any other sources.
Questions to ask before you get an equity loan
Now that you know what an equity loan is, and its prerequisites, you might be thinking of applying for one. Before you do, consider the following.
How much of your mortgage have you paid up?
One important thing to know is that an equity loan is made against the equity you own on your property. This means that you can only borrow as much as the amount you have paid towards your mortgage.
Here’s an example.
Let’s say you own a shoebox condo studio valued at S$1 million, and you have paid up S$200,000 of your mortgage so far. If you attempt to take an equity loan, you will only be able to borrow up to S$200,000 and not the entire S$1 million.
Now, let’s fast forward to 10 years later, and assume that you have paid S$600,000 into your mortgage so far. At this point, you would be able to loan up to S$600,000 through an equity loan.
And what if you’ve already fully paid off your mortgage? Well in that case, you can borrow up to S$1 million through an equity loan.
What’s the interest on your equity loan?
Equity loans may come with lower interest rates, but because of the relatively high amount you are borrowing, you’ll still be paying a pretty substantial sum in interest. Hence, every little bit counts.
When shopping for an equity loan, be sure to consider carefully the interest rates offered. Going for the first one you see may mean having to pay thousands of dollars more later on.
How are you going to pay back the loan?
This is especially important if you’re using an equity loan to fund your retirement.
Understand that even though you’re borrowing against your home, which is an asset you own, an equity loan still has to be paid back.
If not, your debt will be left to the next generation, and surely you won’t want to do that to your family, right?
Hence, you should have a clear plan for how you are going to pay off your equity loan. Yes, you can simply sell your property to pay off your debt, or leave the property to your descendants so they can use it to pay off the loan.
But what if things don’t go as planned, such as not having suitable alternative living arrangements, not being able to find a buyer, or even the value of the property dropping?
This brings us to the next point.
How much should you borrow?
It might be tempting to ‘cash out’ your S$2 million landed property and spend your golden years travelling the world, but you might want to be more prudent instead.
Firstly, there’s the interest on your equity loan, which effectively reduces how much you can actually borrow.
Secondly, should the value of your property suffer a decline, selling off your property may not be sufficient to fully repay your loan. If that happens, you’ll be stuck with debt that you might not have the means to pay off.
Therefore, instead of looking at equity loans as a golden ticket to an unbridled lifestyle, it is wiser to look upon the value of your home as a supplementary source of income.
Try to borrow just what you need, and not necessarily what you want.
Are there alternatives you can pursue instead?
Let’s put it this way. After a lifetime of mortgage payments, are you sure you want to do it all over again? Because that is what you would be doing, if you take up an equity loan.
Before signing up for more mortgage payments, you might want to consider if you have any alternative options instead.
You could sell your property and downgrade to a smaller flat, and make do with the difference.
You could begin a second career as a landlord and earn steady income by renting out your extra rooms.
Or you could move in with your children — or even relocate to a nearby country — while living off the proceeds collected from renting out your entire property.
Read these next:
Being Rich vs. Being Wealthy: What’s The Difference?
How Much Do You Really Need To Afford A Landed Property In Singapore?
What Is A Home Equity Loan And How It Helps Tackle Debt
HDB Loan Vs Bank Loan: Which One Should You Go For?
How Much Do You Need To Buy Your First Home In Singapore?
By Alevin Chan
An ex-Financial Planner with a curiosity about what makes people tick, Alevin’s mission is to help readers understand the psychology of money. He’s also on an ongoing quest to optimise happiness and enjoyment in his life.