Many homeowners have been shocked when, in trying to refinance, they find out they no longer qualify for a new home loan.
Some others are shocked when they can make the down payment, but are still rejected for the loan application due to income.
This is down to the Total Debt Servicing Ratio (TDSR) framework, and here’s what you need to understand:
What is the TDSR?
The TDSR is a loan curb, which limits the maximum size of your home loan (it is not a cooling measure, and it is not temporary).
Under the TDSR, your maximum monthly home loan is capped at 55% of your monthly debt obligations.
This is inclusive of all your debts, such as car loans and personal loans.
For example, say you have an income of $4,000 a month. Your TDSR limit would be $2,200.
If your various debt obligations require you to pay $500 per month, then your maximum monthly payments for your home loan is $1,700.
If your home loan repayment would exceed this amount, you will have to use a longer loan tenure, or make a bigger down payment.
Key facts to consider about the TDSR:
- If one co-borrower passes away, the other may need to meet the TDSR to take over the loan
- The TDSR is not calculated using the current interest rate
- Having variable income makes it harder to meet the TDSR
- The TDSR should affect how you prioritise your purchases
- The TDSR can affect your ability to refinance
1. If one co-borrower passes away, the other may need to meet the TDSR to take over the loan
Have you considered what would happen, if you pass away without paying off your mortgage?
If you have a co-borrower, they will have to inherit the debt if they don’t want to sell the house.
However, your co-borrower may not have this option, if they don’t meet the TDSR requirement. For example:
Say that you and your co-borrower each earn $3,500 per month, for a combined monthly income of $7,000.
Your TDSR – assuming you have no other debts – is $3,850 per month.
Say your monthly home loan repayment costs $2,800 per month.
Under normal circumstances, this meets the TDSR limit. But what happens if you were to pass away?
If your co-borrower has to take on the mortgage alone, their TDSR limit is only $1,925; below the required amount of $2,800.
In such a situation, they may be forced to give up the house.
Note that even if they’re willing to make the loan repayments (i.e. they’re okay tighten their belts to live on $700 a month), they probably won’t be allowed to take over, because of the TDSR limit.
There are some other workarounds, such as pledging a large fixed deposit, or paying a significant lump sum to lower the outstanding loan – but these all require a large amount of cash.
This is why it’s highly advisable to purchase mortgage insurance.
Through policies such as Mortgage Reducing Term Assurance (MRTA) or Level Term Insurance plans, your outstanding home loan can be paid off in the event of death or disability.
This avoids situations where your co-borrower cannot keep the house, due to loan limits.
2. The TDSR is not calculated according to current interest rates
Say your TDSR limit is $3,000 per month. You want a home loan of $750,000, for 30 years.
You check the current rate (about 2% per annum) and see that the monthly loan repayments are about $2,770.
You apply for the home loan…and then find it’s rejected.
This is because when determining your TDSR, the bank does not use the current interest rate.
Instead, the bank assumes an interest rate of 4%.
This is because they want to ensure you can still repay the loan, should the rate rise later on.
A $750,000 loan at 4% interest, for 30 years, comes to a monthly repayment of about $3,580 per month – above your TDSR limit.
So be warned: you may be able to borrow far less than you think.
3. Having variable income makes it harder to meet the TDSR
If your income comes from a variable source, a 30% haircut is applied to it for TDSR calculations.
For example, if you earn $5,000 a month purely on sales commissions, you count as earning just $3,500 a month for TDSR purposes.
Variable income sources include:
- Freelancing or contract work (e.g. driving a ride-share car)
- Rental income
- Sales commissions
- Dividends from stock portfolios
If your co-borrower lives on a variable income, it is much harder for them to meet TDSR limits.
As such, it’s more important for you to get mortgage insurance, so they don’t struggle to get a loan if you pass on or are too disabled to work.
4. The TDSR should affect how you prioritise your purchases
Be strategic in how you use loans, now that you’re aware of the TDSR.
For example, you should choose to buy a car only after you have bought a house; otherwise, the car loan could reduce your TDSR limit by a significant amount.
It’s a good idea to minimise your use of credit, up to 12 months before you try to apply for a home loan.
5. The TDSR can affect your ability to refinance
When refinancing your home loan, be aware that you will be assessed for the TDSR again.
This can impact those who got their home loans in the early 2000’s or before, when the TDSR did not exist.
It’s possible to discover that, while you qualified for home loans back then, you no longer do today under the new TDSR framework.
This can leave you unable to refinance.
Given how tight loan curbs have become, it’s important not to assume your loved ones can take over your mortgage.
Things are no longer as simple as it was in the past when banks didn’t care about your income so long as the monthly payments come in.
Today, your family may not be able to take over if you unexpectedly pass away or can’t work.
Ensure that, besides life insurance, you also have valid mortgage insurance.
You can contact us if you need help finding the best policy, at competitive premiums.
Our wealth planning specialists will compare policies from 13 reputable insurance companies to find the most suitable coverage for your unique needs.
