Why every Singaporean homeowner needs to know the 3-3-5 rule

Singaporeans love using three syllables. There's the PIE, and the MRT. You've got MBS and GST. And of course, our emergency numbers, 995 and 999. If you're a homeowner (or an upcoming one), there's one more to add to that collection: 335. Yep, we're talking about the 3-3-5 Rule.

What is the 3-3-5 rule?

The 3-3-5 rule is a guideline that helps you gauge your home affordability. It is a realistic measure that ensures that you do not over-leverage to purchase your home, especially if it's your first one. Each number in the 3-3-5 rule stands for an amount that should guide you in making your next property decision.

3: Have 30 per cent of property valuation in cash/CPF

The first 3 in the 3-3-5 rule states that you should aim to have at least 30 per cent of your property's asking price in cash or CPF.

Some might be wondering, doesn't this then translate to a loan-to-value (LTV) ratio of 70 per cent for the housing loan? Isn't the standard LTV for bank loan (75 per cent) and HDB housing loan (80per cent) above that threshold? And there's a good reason why a lower LTV of 70per cent is recommended.

That's because there are some hidden costs apart from the property valuation that you need to account for. This includes stamp duties and legal fees, which isn't the first thing that comes to most homebuyers' minds. Therefore, it is prudent to add a bit of buffer by having 30per cent of the property valuation in cash or CPF. As they say, cash is king.

And of course, you can still go ahead to take up a higher LTV with your bank loan or HDB housing loan.

3: Keep monthly mortgage within 30 per cent of monthly household income

The second 3 in the 3-3-5 rule also stands for 30 per cent, but this time of your monthly household income.

Some of you might be considering maxing out your monthly household income for your property. That's doable because the limit set by Monetary Authority of Singapore (MAS) is 55per cent. But here's the thing…

If you max out at 55 per cent, you may not have enough buffer in the event of a loss of employment or future interest rate hike. In fact, we are already seeing how interest rates have risen dramatically in the past year. There's really no way to tell how high the interest rate might go.

By ensuring that you keep your monthly mortgage repayment within 1/3 of your monthly household income, you create enough buffer even if interest rates were to go higher than they are now.

5: Property valuation shouldn't exceed 5x of annual household income

The last point in the 3-3-5 rule is to not overstretch your finances. According to the 3-3-5 rule, valuation of the property that you are eyeing shouldn't exceed 5x of your annual household income.

Some of you might argue that with rising property prices in Singapore, this point is a bit hard to keep up with. For instance, if you and your spouse earns $10,000 as a household, your annual household income sums up to $120,000. At 5x of your annual household income, that puts your property affordability at $600,000. An HDB resale flat may still be within reach, but a private property is definitely way out of your options.

How to ensure your affordability with 3-3-5 rule?

By keeping within all three points of the 3-3-5 rule, it helps you stay prudent on the property that you are about to purchase. It gives you a good guideline to follow for financial prudency so that you don't overstretch your finances. That said, it isn't a hard and fast rule and you can adjust it accordingly if needed.

3 Hacks you can try to afford a more expensive home within the 3-3-5 rule

1. Rent out a (few) room(s) to earn passive income

If you want to keep the mortgage repayment within 1/3 of your monthly household income, one way is to increase your monthly household income. This will boost the dollar value of the monthly mortgage repayment that keeps to the 1/3 threshold. That said, it isn't always easy to increase your pay, whether that's in getting a raise or finding alternative sources of income.

One hack you can try is to consider renting out a room in your new home. This helps you to create passive income that raises your monthly household income without you working too hard for that pay raise.

2. Manage the loan tenure on your mortgage

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The monthly repayment that you make on your housing loan is a factor of two things: Loan tenure and interest rate (see next point).

For the loan tenure, the longer you drag your loan, the more interest rate cost you are going to incur. This increases the overall cost of property ownership.

For example, if you take a bank loan of $1 million at an interest rate of three per cent for 20 years, the overall cost of home ownership is $1.331 million. Over the course of 20 years, you are paying $331,000 as interest payment to the bank.

Contrast this with the next scenario where you take out a 30 year loan at the same amount and interest rate. The overall cost of home ownership shoots up to $1.517 million.

Obviously, there are some pros in doing so. Having longer loan tenure means that your monthly loan repayment amount is lower: $4,216 (30-year) vs $5546 (20-year).

While this helps you keep to the second 3 in the 3-3-5 rule, make sure to use this lever on loan tenure wisely. You might even want to engage a mortgage consultant like Mortgage Master to advise on this move.

3. Save On Interest Rate Of Your Bank Loan

The other lever that you can adjust to stay within the 3-3-5 rule is the interest rate on your bank loan. By seeking a bank loan that offers a lower interest rate, you will find it easier to stay within the 3-3-5 rule.

Let's say you are taking a bank loan of $1 million for 20 years. If the interest rate is five per cent, your monthly mortgage repayment is $6,599. But if you take advantage of great deals by your mortgage consultant to lower that rate to three per cent, the monthly mortgage repayment goes down to $5,545. That's a 16per cent reduction in monthly mortgage repayment!

ALSO READ: 4 tips to help you become a homeowner in Singapore at an affordable rate

This article was first published in Mortgage Master.