The DBS Home Equity Income Loan: Good or Bad?
One of the things that modern finance and investment theory is at odds with the real world is that we are mainly taught about investing in stocks and bonds. The more exotic investments in real estate, private equity, hedge funds, commodities are usually the preserve of sophisticated institutional investors. Yet, in the reality, almost every individual has a big investment in his own home. Often, this dwarfs his or her investments in stocks and bonds. Even in countries where home ownership is lower, such as Germany, more than 50% of the population own their own homes. As a result, unlocking the value of the equity in one’s home, through home equity loans and reverse mortgages, is a key, but as yet not fully developed part of personal finance, especially for retirement.
This is also a problem which retirees and homeowners here have been struggling with. Although there are solutions, such as downgrading to a smaller home, or renting out a spare room, not everyone is keen to move or share a home, especially when they are older. But for the HDB dwellers, there is the HDB Lease Buyback Scheme (LBS), which we discussed here, and uncovered what a great deal it is for HDB owners (even if it is not commonly appreciated). But what about the private property owners? They seem to have been left out, until DBS announced the Home Equity Income Loan (EIL).
The DBS Home Equity Income Loan (EIL)
The details of this new home loan scheme have been well covered in the press (here and here, and also here and here), as well as by the blogosphere (here and here for example), so we won’t rediscover the wheel here. Instead, we will let DBS do the explaining themselves:
What are the choices retirees have for monetising their private apartment?
Here are the key features of the DBS Home Equity Income Loan (EIL):
Here’s how the DBS EIL works, through an example:
A deep dive into the DBS Home Equity Income Loan
Hopefully, these news articles, blog posts and DBS promotional materials have made it abundantly clear how the DBS EIL works. If not, the TL;DR version is that:
- It is a 30 year loan (maximum tenure)
- Secured against the private property. This needs to have at least 30 years of its lease left at the end of the loan term
- Proceeds of the loan are to be put into CPF Life. This caps the loan quantum at the current Enhanced Retirement Sum at the point the loan is made
- The interest rate charged is 2.88% simple interest (i.e. no compounding of interest)
- All loan principal and interest payable only at the end of the loan (or when the loan is redeemed)
With these details out of the way, let’s focus on the three big questions which seems to be curiously ignored so far in the discussion about the DBS EIL, namely:
- Is this the best scheme there is? Can there be better ways to monetize the value of a private property for retirement?
- Doesn’t the interest rate of 2.88% look a bit high? Especially when compared to home loan rates which are around 1% to 1.5% currently?
- Given that the loan quantum needs to be put into CPF LIFE, which stops paying out when I pass on, while the full quantum plus interest still needs to be repaid to the bank, how do I know if this is a good deal for me?
Let’s take a look!
1. Is this the best scheme there is? Can there be better ways to monetize the value of a private property for retirement?
Owner-occupied property is, and will continue to be the the largest investment in most retirees’ portfolios globally. As a result, there has been an unending stream of financial innovations designed to help monetize, or unlock the value of this investment, while allowing retirees to age in place. For example, reverse mortgages have become a standard offering in the West, where a retiree can pledge the value of his or her property in exchange for a stream of payments for the rest of his or her life. Or a home equity line of credit can be offered to the retiree, allowing him or her to draw down as and when needed over the retirement period to supplement other sources of income.
Sadly, none of these innovative approaches are available in Singapore. One of the main impediments is of course the 99-year leasehold of most private property in Singapore. This eventually results in the property’s value going down, leaving the loan extended by the bank un-recoverable. The second is the regulatory framework for mortgage loans, which requires income from work for the loan to be granted, and subject to the Total Debt Service Ratio (TDSR) requirement. Then there is also the matter of extending a loan or an income stream to the retiree with no guarantee of when it would be paid back, given longevity trends.
To get some idea of the challenges associated with trying to monetize a leasehold private property for retirement, note that the conditions laid down by DBS for the borrowers (i.e. 65 years of age, fully paid up property) mean that the borrowers will probably have bought the property about 30 years ago when it was brand new, or at least fairly new, and then spent most of their working years paying the loan off. This means that when the EIL matures, there is going to be 40 years, or less of the lease left.
As we show here, the running down of the lease according to Bala’s Table means that the property’s value will peak around the 70th year, and starting plunging thereafter. Basically, it is a race against time at the end of the loan to sell off the property before the value falls so sharply that there is not enough to cover the loan repayment!
The dynamics of the value of a leasehold condominium over the lease
Hence, the sort of retirement products which help to monetize the home equity of retirees tend to:
- Be of a fixed maximum tenor (e.g. the 30 years maximum of the DBS EIL)
- Have certain conditions tied to the remaining lease of the property in question. Both the DBS EIL and the HDB LBS have these requirements
- Be tied to an external annuity scheme e.g. the CPF LIFE
So, the answer to this question of whether there are better products for monetizing the value of your property in retirement is “No”. And don’t hold your breath for another bank to provide a better product through competition either. The addressable market for such products (i.e. private property) is so small that is really is a form of national service for the bank in question. As a rough estimate, there are about 400,000 private residences in Singapore. Suppose only 20% of these are eligible for the DBS EIL, and they borrow on average S$200,000. This amounts to only S$16 billion, which is 4% of the total loans DBS has. So there is very little incentive for any bank to compete aggressively for these customers.
2. Doesn’t the interest rate of 2.88% look a bit high? Especially when compared to home loan rates which are around 1% to 1.5% currently?
One of the possible bugbears on first sight of the DBS Home Equity Income Loan (EIL) is the “high” interest rate of 2.88%. This is especially so when we compare it to the interest rates of housing loans. But wait! Floating rate housing loans which have rates between 1.00% to 1.50%, are not comparable to the DBS EIL, which is a fixed rate loan. Fixed rate housing loans currently have interest rates between 1.60% to 1.80%, for the first few years. Is the interest rate charged on the DBS EIL really so unreasonably high?
In the first place, there is a vast difference between loans which require monthly repayments to be made (e.g. a typical housing loan), and one which only has a final payment (i.e. the DBS EIL). The risk to the bank is lowered significantly if the loan is gradually paid down on a regular basis in a housing loan. Who knows what could happen at the end of the 30 years of the DBS EIL? So, it is not unreasonable for the DBS EIL to demand a higher interest rate.
Secondly, lost in the fine print of the DBS EIL, is that the 2.88% interest rate is a simple interest rate. That is, the interest accrued on the loan over thirty years is not compounded (clarified here). All you have to repay at the end of the 30 year period is just 30 x 2.88%, plus the loan principal. And a direct comparison with the 1.60% to 1.80% of a typical fixed rate housing loan in not appropriate. In fact, the DBS EIL actually gets cheaper in equivalent interest rate terms the longer you take it out for:
Equivalent compounded interest rate for the DBS EIL by loan tenor
|DBS EIL Tenor||DBS EIL Simple Interest||Equivalent Compound Interest*|
Hence, it is really true that the longer you borrow under the DBS EIL, the cheaper it becomes to borrow! And it isn’t much more expensive to take up the DBS EIL compared to a typical fixed rate housing loan. But even that is not a good comparison, because the loan principal of a housing loan will be repaid over time, whereas that of the DBS EIL will only be paid back at maturity. A better comparison would be against the yield of 30 year Singapore Government Securities (SGS), which locks up the principal for 30 years. Here is what the current yields on SGS look like:
Yields on benchmark Singapore Government Securities in August 2021
|SGS Maturity||Benchmark Yield (Aug 2021)|
Hence, if the bank really wanted to lock up its money for 30 years with minimal repayment, it could do so by buying a 30-year SGS which will give it an interest rate of 1.83%. Or it could lend out to a retiree for 30 years, and incur the costs of possible non-payment in 30 years time, and also the manpower and process costs of tracking the loan, reporting, paperwork and such. And all for an effective interest rate of 2.10%! These things which a bank needs to do for extending a loan are obviously not free. From this perspective, the DBS EIL’s interest rate of 2.88% (simple interest) really looks like a bargain for the retirees taking out the EIL!
3. Given that the loan quantum needs to be put into CPF LIFE, which stops payments when I pass on, while the full quantum plus interest still needs to be repaid to the bank, how do I know if this is a good deal for me?
Thus far, our analysis has shown that:
- It is unlikely that a product much better than the DBS EIL will come onto the market for monetizing the value of a private property for retirement, especially through competition amongst banks, since there are virtually no incentives and plenty of challenges in doing so
- The pricing of the DBS EIL, at 2.88% simple interest, looks high. But it is actually very reasonable in comparison to how much that even the government has to pay to borrow for 30 years
But the question still remains, is it worthwhile for a retiree to take this loan?
Going by the example provided for the DBS Home Equity Income Loan (EIL), the answer seems to be “Yes”. After all, when the loan proceeds are put into CPF LIFE, even for a 65-year old woman, for which CPF LIFE pays the lowest monthly payout, the payout amounts to 5.83% of each dollar put in (she gets $850 more per moth for putting in $175,000). This represents a spread or profit margin of almost 3.00% above the loan rate in simple interest terms (ignoring present value and compounding) and 3.70% when we take present value and compounding into account. What a good deal!
The problem is, of course, that it is a guaranteed good deal if you live to collect all the possible 30 years of CPF LIFE payments. Which means living to a ripe old age of 95. And which is probably not possible for everyone. What then is the breakeven age beyond which it is a good deal to take up the EIL?
Let’s go back to the example provided by DBS. For the 70-year old man, he puts $115,000 into CPF LIFE, and receives an additional $650 a month, or a yield of 6.78%. For the 65-year old woman, she puts $175,000 into CPF LIFE and receives and additional $850 a month, or a yield of 5.83%. We can present value these additional income streams, discounting them by the effective compounded loan rate of 2.10% (see analysis in previous section) to figure out at what age the present value of these additional income streams is greater than the initial amount put into CPF LIFE:
Present value of additional income streams from CPF LIFE given survival till a certain age
|Loan Term||Age of Man||Present Value of CPF LIFE||Age of Woman||Present Value of CPF LIFE|
What we can see from our calculations (not all shown above) is that the man needs to survive 16 years to age 86, and the woman needs to survive 20 years to age 85, to break even on the Home Equity Income Loan. This seems to tie in closely with our previous analysis on CPF LIFE (here and here) where the breakeven age for a man on the Standard Plan is 85 and that for a woman is 87. So it appears that the structure of the DBS EIL and CPF LIFE is similar in that both will break even as long as you survive past the age of 85 to 87, regardless of your age when you first started the payouts. The corresponding break even ages for the Escalating Plan are 88 to 90.
Is living to such a ripe old age possible? Well, according to the latest Singapore Life Tables (2020), the life expectancy for a man aged 65 is 85 years, and for a woman, 89 years. This means that half of all the 65-year olds in Singapore will live beyond the DBS EIL and CPF LIFE break even ages. And remember, the Singapore Life Tables are for everyone aged 65 today, healthy or sick. Which means that if you are healthy right now, you have a better than 50:50 chance of breaking even on the DBS EIL and CPF LIFE! Note that for the 70-year old man in the example above, his life expectancy is age 86, which is also the break even age.
So, our conclusion on the DBS Home Equity Income Loan is:
If you are a healthy retiree, you stand a better than 50:50 chance to break even or profit from taking up the Home Equity Income Loan, regardless of the age you start your CPF LIFE payouts!
Conclusions: Is it worth it?
The DBS Home Equity Income Loan (EIL) was introduced in August 2021 to quite a bit of fanfare and press coverage (as well as blog coverage). However, after the initial write-ups on how it works, things seem to have quietened down. Why? Probably because no one has tried to analyse it in detail for whether it is worthwhile to take up or not.
But fear not, because this sort of tedious analysis is right up our alley, and indeed, our specialty and goal. We look at this from three perspectives:
- Is this the best product for monetizing our private property for retirement?
- Is the interest rate of 2.88% unreasonably high?
- Will I live long enough to break even on this loan?
- This is not the best possible product, but given the lack of incentives, the small size of the market, the challenges in dealing with leasehold property and banking regulations, it is unlikely that there will be anything better. In other words, this is as good as it gets. And it is not bad overall, in case you are worried about this reluctant endorsement!
- The 2.88% interest rate looks high, but it is lower than it appears, as it is simple interest, and works out to be around an effective compounded interest rate of 2.10%. Which in turn, is reasonable, for taking the bank’s money and not needing to repay a cent over 30 years.
- If you are on the CPF LIFE Standard Plan, the break even age to attain is to 86 years old. And for a retiree aged 65 today, you have a 50% chance of outliving this. If you are on the Escalating Plan, this will be a little harder, as the break even age to attain is 88 to 90.
Despite all this, would people still be reluctant to take up the DBS Home Equity Income Loan (EIL)? Yes, primarily because there is a belief that we should leave the property to our children, and not have to sell it to pay off our loans. But this is a wrong-headed belief! Due to the Additional Buyer’s Stamp Duty (ABSD) regime in Singapore, it is always better to sell off the property for profit and split the cash, rather than to leave it in equal shares to our children (unless you only have one child). And the DBS EIL goes one better than the HDB Lease Buyback Scheme, as it allows your heirs to benefit at least partially from increases in the property’s value (if any, and after paying off the bank). This is something which is missing from the HDB LBS.