Question 2 Building up HOme equity (32 marks)

Clearly state and explain any assumptions you may make.

Mr and Mrs Lee, a married Singaporean couple both aged 31, are considering buying their first home. They are currently staying rent-free with Mr Lees parents and have no other debt. The Lees are interested in a private freehold unit which is under construction. The unit is expected to get its TOP (Temporary Occupation Permit) in 3 years. The purchase details and the projected progress payments are shown below.

If the last digit in your matric number is odd, use Project A.

If the last digit in your matric number is even, use Project B.

				Project A	Project B
Developer's price				$1,275,000	$1,300,000
Down-payment due now (t = 0)
Cash				5%	5%
Cash &/or CPF				20%	20%
Balance
1 year from now (t = 1)				40%	35%
2 years from now (t = 2)				20%	20%
3 years from now (t = 3)				15%	20%

The Lees intend to conserve cash by getting the maximum possible loan and utilizing all the monies in their CPF (Central Provident Fund). At present, their bank is offering the following loan for properties under construction. FHR8 is the banks prevailing 8-month fixed deposit rate. All rates are annual and the loans are payable monthly.

				Properties under construction
Fixed interest rate for Year 1 (t = 0 to t = 1)				1.80%
Fixed interest rate for Year 2 (t = 1 to t = 2)				2.00%
Floating interest rate from Year 3 onwards				FHR8 + 1.5%
Current FHR8				0.50%
Forecast FHR8 in Year 3 (t = 2 to t = 3)				1.00%
Forecast FHR8 in Year 4 (t = 3 to t = 4)				1.20%
Forecast FHR8 in Year 5 (t = 4 to t = 5)				1.20%
Lock-in period (years)				3
Prepayment penalty (% of outstanding loan balance)				1.5%
Tenor of loan (years)				30

You have the following information:

• Mr Lee earns $9,000 a month while his wife earns $5,500 a month.

• The Lees have a combined savings of $330,000 in their joint bank account and a total of $300,000 in their CPF Ordinary Accounts currently.

• Buyer stamp duty is payable at the normal tiered rates. The developer will absorb the legal fees.

• The maximum loan that can be taken will be the lower of the following two amounts:

• Under the LTV [Loan-to-Value] rule, the maximum loan cannot exceed 75% of the purchase price or market value, whichever is lower;

• Under the Total Debt Servicing Ratio [TDSR] rule, the maximum housing loan amount is when 60% of the monthly salary is used to service the loan assuming the interest rate is 3.5% p.a., monthly rest, for 30 years.

• Stamp duty is payable on the loan at 0.4% of the principal amount subject to a maximum of $500.

• The CPF Ordinary Account interest rate has been 2.5% p.a. on a monthly compounding basis and looks to be so for the next 5 years.

1. What is the absolute minimum cash amount that the Lees require to purchase the condominium? Can they afford it?

(4 marks)

2. After paying the minimum cash component in (a), what is the remainder of the outlay for purchasing the private unit now? How much of this will be paid for by CPF funds and how much by cash?

(4 marks)

3. Compute the maximum loan principal that the Lees can borrow based on the prevailing (Loan-to-Value) LTV and TDSR (Total Debt Servicing Ratio) rules. Justify how you have applied these rules based on the Lees circumstances.

(6 marks)

4. Calculate the monthly payment for the first 4 years of the loan. Show the cash top-up if the Lees utilize all their CPF contributions to service the mortgage?

(6 marks)

5. After 4 years from the purchase date, the Lees are thinking of selling the home. They will do so if the net sales proceeds after repaying the bank loan and their CPF Accounts can earn an annual return of 20% on their equity. The equity comprises the cash outlay for the purchase price (calculated in parts (a) and (b)) and cash top-up (calculated in part (d)). Assume that selling costs are 1% of the transacted price. What is the minimum price at which the Lees must sell their unit 4 years from today?

(7 marks)

6. Briefly state two main considerations that the Lees should bear in mind before deploying all their CPF funds for buying the new home. How would you advise the Lees based on all the financial considerations?

(5 marks)