You have landed a decent pay rise and after looking for a new property, you have hit on one that requires a mortgage of $800,000 after paying the deposit with your savings and CPF money.
You do a quick calculation and find that you can afford the monthly repayment of about $3,000 as you still have more than $1,000 to spare after paying for your regular expenses.
But wait – if you are working on such a tight budget, you may want to redo your sums because if the interest rate were to go up by a percentage point or two, you won’t have any spare cash left from your salary. This means you would need to use your savings for emergency expenses, which will certainly hurt your retirement planning.
This is why the Monetary Authority of Singapore (MAS) sounded a warning recently when more households took on new home loans at a time when interest rates are expected to rise gradually.
It noted that people with high exposure to debt should not take on more loans but try to build up financial buffers to be better prepared for any market uncertainties.
Frankly, you should not need the MAS to remind you to be more prudent with your money.
Here are four financial health checks you can make to ensure you’ll always have enough money.
1. More income than debt
To check whether you have a good cash position every month, add up all your fixed monthly loan instalments and divide this number by your monthly income or salary (total loan/total income).
This is your total debt servicing ratio (TDSR), which banks use to decide if you will get the loan for your new property.
If your total loan is more than 55 per cent of your income under the stricter regime for new home loan, it is a sign that you should look for a less expensive home or fork out more cash to reduce the loan quantum. Another way is to pay off your other debt first before you ask for a new home loan.
You should always prioritise which big-ticket items are more important to you. This is what planning is all about. For instance, there is no need to buy a home and a car at the same time. You can always pick up the other item after your next pay rise, which would improve your TDSR score.
2. Always have enough to spend
Everyone should do this check because it determines if you have enough money should you face a dire situation such as a major recession.
You first need to have an accurate number on how much your family actually spends every month. You can do this only if you add up all your bills for essential monthly expenses such your grocery, utilities, phone, transport and other household items.
You also need to add up all your loans and insurance premiums since you cannot avoid paying for these. Once you have this number, divide your total cash savings by it as this will tell you how many months you can last if you were to suddenly lose your income (total cash savings/monthly expenses).
If the result is a single digit, start to save more because some downturns, such as the current Covid-19 pandemic, can last for a few years. This exercise also gives you an idea of how prepared you are for retirement because you will truly need to rely on your savings for your expenses then.
When you calculate how many months you can last, only cash should be considered. Your jewellery and expensive watches usually don’t count unless you are prepared to sell them at lower prices during a recession. Gold bars do count though: these are easier to cash out and they usually increase in price during a downturn.
3. Don’t be asset rich, cash poor
There are two ways to check this. First, find out the value of your home and then deduct your outstanding loan from this amount.
After that, use your total cash savings and then divide this by the result (cash/asset minus loans).
If your score is below 15 per cent, then you officially belong to the group of home owners who have over-leveraged on properties because you do not have much cash.
To avoid this, you should follow the MAS advice and work out the numbers and do not take on more debt if you do not have ample cash savings.
Just remember one thing – it is never wise to sell assets in a recession because this often results in losses. If you are reluctant to part with your properties, here is a tip to increase your cash reserves – cut down on non-essential spending and expenses until you see more digits in your bank accounts.
4. Good to have a reserve
You can’t judge a person’s wealth by just looking at his home or the fancy car he drives. If these assets are bought with huge loans, it simply means the owner has over-leveraged and that he could lose them if he cannot keep up with the loan payments.
To see whether your reserve can weather any storm, add up all your debts and then divide by the value of your cash and assets (Total debt/total cash and assets).
The ideal ratio should be way below 50 per cent. Unless you are the banker, don’t view a loan as good just because its interest rate is low now. All loans have to be paid eventually, so it pays to keep a close watch on your debt to ensure it does not whittle away your savings when you need it most for old age.
Source: https://www.straitstimes.com/business/invest/4-tests-to-check-if-you-are-financially-healthy
