Question:
Hi, I’m Ben, a 30-year old Sales Manager working for an IT Software company in Petaling Jaya. I’m earning a monthly income of RM 7,000 a month and I’ll like to purchase a condominium for RM 500,000. As I write, I have set aside RM 50,000 in liquid assets (cash, stocks, and unit trust) and I’m paying RM 1,400 per month in total debt installments (car loan and PTPTN).
As this is my first time buying a property, what are the financial considerations I should be aware of to be financially fit to purchase the property?
Answer:
For most, real estate is the single biggest investment or item that anyone would spend on in a lifetime. Thus, it is advisable for all to be financially fit first before committing to purchasing a piece of property. In this article, I’ll share three key financial criteria which serve as a checklist to assess if you are financially steady enough to buy your next property:
Criteria 1: Debt Service Ratio (DSR)
DSR measures a person’s level of debt commitment in regards to his income. As for Ben’s case, his current debt commitment is RM 1,400 a month, which is 20% of his income of RM 7,000 a month. Thus, Ben’s current DSR is 20%.
Ben’s Current DSR
= (Current Monthly Debt Instalments / Monthly Income) x 100%
= (RM 1,400 / RM 7,000) x 100%
= 20.0%
From above, Ben intends to purchase a condominium costing RM 500,000. As it is his first purchase, Ben is eligible for a mortgage amounting to 90% of the cost of his property, equating to RM 450,000 for a maximum loan tenure of 35 years as he is below 35 years old.
Let’s assume that the mortgage rate is 3.5% per year. Ben’s mortgage payments work out to be RM 1,860 a month. Thus, if Ben successfully made the purchase, his new DSR, inclusive of his mortgage, would be increased to 46.6%.
Ben’s New DSR
= ((Current Monthly Debt Instalments + Mortgage) / Monthly Income)) x 100%
= ((RM 1,400 + RM 1,860) / RM 7,000)) x 100%
= (RM 3,260 / RM 7,000) x 100%
= 46.6%
Ideally, it is best for Ben to keep his DSR at below 40% after having included the mortgage payments of his property. If his DSR increases to above 60%, 70% and even 80% after buying the property, Ben is putting himself at great financial risk for he could be stressed out in making his debt repayments if he loses his job or has little in cash savings.
Tip #1: Keep DSR Below 40% After Purchasing a Property
Criteria 2: CCRIS and CTOS
From a banker’s perspective, he would prefer to loan money to a borrower who not only is able to repay his borrowings (assessed by Criteria 1: DSR) but also is one who is trustworthy to repay his borrowings promptly. As such, a banker will evaluate a borrower’s debt repayment records for the past 12 months to assess whether or not the borrower is consistent in repaying his debts on-time.
To do this, the banker will retrieve your CCRIS and CTOS reports.
So, here is a tip. You can purchase your own CCRIS and CTOS reports before you apply for a mortgage. From these reports, you will be given credit scores, which tell you how bankers will rate you as a potential borrower. For instance, you will be more likely to qualify for a mortgage if your credit score is high. You may risk being rejected by a bank if your credit score is low.
Thus, if your credit score is low, you can take the next 12 months to improve on your credit score before applying for a mortgage. Of course, if your credit score is high, you may want to maintain the score to qualify for your mortgage.
Tip #2: Improve and Maintain a High Credit Score
Criteria 3: The 25% Rule
The 25% rule is a ballpark figure to estimate the amount of cash that you would need to prepare to buy a property. In Ben’s case, his property costs RM 500,000 and thus, he needs to prepare RM 125,000 in cash to buy the condominium.
Initial Capital Outlay for a Property (For First Time Buyers)
= Property Cost x 25%
= RM 500,000 x 25%
= RM 125,000
Why 25%? This is because you would need to incur:
As Ben has RM 50,000 in liquid assets, he is short of RM 75,000 in spare cash to buy his condominium.
What if You Are Not Financially Fit to Buy Your Next Property?
Are you discouraging me to buy a property?
Nope.
Rather, if you’ve learnt that you are not financially fit to buy your next property, I reckoned you to have a 1-3 year plan to improve your finances so that you are financially and mentally more prepared to own your next piece of property.
For instance, let’s say, Ben has a good credit score but falls short in cash and his DSR. Thus, his problem is a lack of income. There are two ways to go about it:
First, Ben may choose to buy a lower-priced property and thus, needing a lower amount of capital.
Second, Ben may choose to find ways to increase his active income and puts his plans to buy his condominium on hold. Personally, I would prefer this option for it is more encouraging to me than the first. Imagine that Ben is able to grow his monthly income to RM 10,000 and thus, save an additional RM 3,000 a month.
He would be able to raise the current shortfall of RM 75,000 in 2-3 years and as a result, buy his RM 500,000 property. Now, here’s something cool. After he has made the property purchase, his income is RM 10,000 a month. This allows him to raise capital for his next property much quicker than buying his first property and thus, allowing him to build wealth much faster as compared to his peers.
For now, I’ll list 3 food for thought to help you reflect if you are financially fit to buy your next piece of property:
1. Keep DSR below 40%, inclusive of new purchase of property
2. Good Credit Score: Check Them Out with your CCRIS and CTOS reports.
3. The 25% Rule: Have 25% of Property Cost in Spare Cash.
