Singaporeans may need to service their mortgage in cash if they run over the CPF Withdrawal Limit.
Many Singaporeans know how HDB loans work, but they're still fuzzy on the details of the CPF Withdrawal Limit (WL). It's important to understand this, because it can result in you having to service your home loan in cash. If it catches you off-guard, you could end up taking out some big and expensive loans. Here's what you need to know:
Important note: The following only applies to resale flats, or flats purchased using bank loans. If you buy a new flat using the HDB Concessionary Loan, the limit does not apply to you.
What is the CPF Withdrawal Limit (WL)?
There is a limit to how much of your CPF you can use, when buying a resale flat, or any flat through a bank loan. Once the WL is reached, you can no longer use your CPF monies for home loans or new properties.
The CPF WL is paired with another factor, called the Valuation Limit (VL) on your property.
The VL is always the lower of your property price, or the purchase price. For example, if you bought a flat for S$640,000, but the valuation of the flat (according to HDB) is only S$610,000 then the VL is S$610,000.
Once you have withdrawn an amount equal to the VL from your CPF, you must set aside the Basic Retirement Sum before you can continue using your CPF monies. (You will have to set aside your cohort's Basic Retirement Sum if you are aged 55 and above, and the prevailing Basic Retirement Sum if you are below age 55.)
Now besides the VL, you have to contend with the WL.
The WL is pegged at 120% of the VL. For example, if the VL of your property is S$500,000, then the WL is S$600,000. Once you've withdrawn this amount from your CPF, the rest of your home loan must be paid in cash.
How Can That Happen?
Remember that your flat ultimately costs more than its purchase price, due to the interest rate on the home loan.
For example, let's say you buy a resale flat for S$500,000. We will also assume the valuation is the same as the purchase price (i.e., the VL is also S$500,000).
You borrow S$400,000 (you can normally borrow up to 80% of the apartment's price from a bank loan), and put down a down payment of S$100,000. Of this downpayment, S$75,000 comes from your CPF.
Let's say you have a 30 year loan, at 2.2% per annum (bank loan rates fluctuate, but this is a safe average to assume in the long term, from 2017 onwards). Such a loan would have a monthly repayment of around S$1,519.
On top of that, remember that you already spent S$75,000 of your CPF on the down payment.
Now at such a rate, you will reach the VL by around the 23rd year of the loan. At that point, you will have to set aside the Basic Retirement Sum, which stands at S$83,000 currently.
If this causes you to run out of CPF money in your OA (far from impossible, given the down payment and the amount you're using to service the loan every month), you would have to start servicing the loan in cash.
Assuming you have enough CPF monies to set aside the Basic Retirement Sum and still keep paying, you will still hit the WL at around the 29th year of the loan. This leaves around one year, in which you have to pay for your home loan in cash.
One major problem is that the WL tends to be reached late in life. In the above scenario, you would be near the age of 65 when you hit the WL. It can be devastating to have to pay your home loan in cash, if you are already retired by that point.
Also, note that we are counting on home loan interest rates remaining more or less stable. Interest rate hikes are being planned in the United States, which will cause Singapore's home loan rates to rise as well.
A spike in rates can cause you to reach the WL a lot sooner.
What Can We Do About It?
When buying a house, ask an independent mortgage broker to work out when your WL could be reached (you can find these brokers at various home loan comparison sites). This will allow you to prepare to service your loan in cash.
You could also consider servicing the first part of the loan (say the first 10 years) in cash, after which you can safely count on your CPF reserves to cover the last half of the loan as you near retirement.
Finally, you can make the effort to observe home loan rates, and refinance into cheaper options when your home loan interest gets too high.