This is a proposed re-draft of the following article which promotes the FundMyHome scheme found here.
I’m not against the scheme but I think certain financial concepts are amiss when comparisons aren’t made on a like-for-like basis and the free-rent feature isn’t fully assessed.
I haven’t read the very long T&C in full, so if I’ve missed out any of the main principles or fine print I do apologise and stand corrected but the scheme’s main features are garnered from the FMH website
In the meantime here is my proposed re-draft. Strikethroughs are done on the original wording of the article, italics are my suggestions as are the tables.
WhoWhat are the risks and benefits?
Scenario 1 : If you are renting
Say you and your spouse are in your late 20’s. You have two beautiful children. You earn just over RM5,000 a month – barely enough to cover your car loan, groceries, utilities and other expenses. You’ve correctly delayed buying a house and are renting a 3-bedroom, 900 sqft apartment for RM1,250 a month. Instead of renting blindly, you have done your homework which led you to renting a home with a 2% yield (yearly rental divided by property market price), implying the house has a market value of RM750,000.
How can FundMyHome help you buy a home (or not if you decided renting is still a good option)?
First up, it offers a variety of homes to suit your family’s needs. Now, let’s say you choose a newly-built apartment costing
RM300,000RM750,000, similar to the kind of home you’re renting now. It’s fine to downgrade and buy a RM300,000 home, it will save you a lot of money. By the same token, you can also save a lot of money by renting a RM300,000 home with the same yield of 2% which would reduce the rental of that home substantially to RM500 per month vs the RM1,250 you’re paying right now.
Back to buying the RM750,000 house under FundMyHome, you need to pay
just20% of the purchase price to secure your home. FundMyHome will helpraise the balance of 80% from institutions by giving them an attractive deal of downside protection and upside potential of up to 20% of your property price movement. In other words, you bear losses up to 20% and they take profits up to 20% before sharing it 80-20 with you thereafter. You can risk burdening yourself and take a 5-year personal loan of RM60,000RM150,000 at 5% p.a. Once the buying process is completed, including vacant possession, your family can move in.
Yes, you will
stillneed to pay RM1,250RM2,850 monthly to service your personal loan. But the big difference is, while previously you paid rent, your monthly payments now go to building up your equity and the bigger difference is that you will have to more than double your monthly cash outflows to buy the home compared to renting it. If you service your loan promptly each month, it will also improve your credit rating. By the same token, if you just rented and paid rent promptly and did not take up debt, your credit rating would also be quite ok. While your family enjoys the security of living in your own home, without worrying about rental increases or the landlord asking you to vacate, you still have to worry about a few things.
You have to rebudget to meet the more than doubling of monthly outflows.
You also potentially still may not qualify or have the means to get financing when the scheme expires in 5 years. If your property price came down under this scenario, you stand to lose a substantial sum of money, meaning you’ll be in negative equity.
These factors are added on top of the fact that you could have for the sake of avoiding indebtedness just rented in the first place a home with longer term leases and slow rental inflation thereby reducing the risk of getting kicked out.
At the end of five years, you will have equity worth
RM60,000RM150,000 in a home under your name unless your house price goes up in which case you would have to cough up more downpayment money and have more mortgage debt than if you bought through a traditional mortgage.
In financial jargon, this is like shorting on margin financing: where you got to top up your money if your property price goes up at the end of 5 years since a short is a gamble for the asset price to go down.
This scenario of losing money if your property price goes up can effectively be treated as rent. The effect is also the same if your property price goes down: you’d have to bear the losses if you didn’t have the ability to continue or get financing for the scheme at the end of 5 years. Property goes up, property goes down, there’s a rental element.
Since you have a 2% rental yield target, you will wish your costs through FMH won’t be more than 2% p.a. Since 1% p.a. is already taken up by the personal loan (20% share x 5% interest) your tolerance for property movement is a razor-thin up or down 1% p.a. to keep you in a rent-neutral situation. If the property moves more than that, you would be better off either renting or buying with traditional mortgage.
The scenario is very different if you just bought the home with a direct mortgage (which in the first place you didn’t have the ability to do anyway since you borrowed the downpayment money). In that scenario, you would benefit from all the appreciation of your property value and you wouldn’t have had to pile on more debt and downpayment.
If you had continued to rent,
you would have nothing to show forthe 5 year’s worth of difference between rental paid and the loan repayment avoided of RM1,600 (RM2,850 - RM1,250) a month could have been invested it at say 5% p.a. to accumulate assets worth RM109,000, a sum big enough to still give you options to buy a property if you wanted to stop renting at that point while at the same time avoiding the speculative nature of the scheme. The returns are of course not guaranteed but neither are property returns. At least with a portfolio you’re making a bet with diversification unlike the scheme which is akin to putting all your eggs in one property with the strange hope that its value doesn’t move much.
Of course the disadvantage of renting is exposure to inflation but it can be argued that rental in general doesn’t go up as fast as capital values especially after you sign a tenancy agreement.
Scenario 2 : Giving your child a head start
Isn’t retirement wonderful? You have your own home, with your pension and savings to meet your simple needs. But one worry keeps you up at night – your 28-year old daughter still hasn’t managed to buy her own home. The other thing keeping you up at night - is it better to rent cheaply or buy at all cost? This could be the stuff of cultural, and dare you say, even financial media misconception. Despite graduating with an accounting degree
and securing a good job, the cost of food, transportation, clothing and some simple entertainment eats up all of her salary, crippling her ability to buy a homeshe is still keen to work out the maths of renting vs buying.
You want to help secure her future and are either willing to make the downpayment on a nice property in an accessible location or invest straight up for her. But the question is – should she opt for a conventional 30-year, fixed-rate mortgage at 4.5% interest or FundMyHome or rent? Let’s compare, using a 3-bedroom apartment costing RM300,000 as an example.
Under both financing options, your daughter would need to pay RM60,000 upfront towards 20% equity in the home. A bank lends the remaining 80%, burdening your daughter with a mortgage of RM1,216 in monthly repayments. “Burdening” is a correct word because renting the same home might just cost RM500 per month. FundMyHome, on the other hand, raises the balance of 80% from institutional investors who want to exploit the opportunity provided by the attractive terms of downside protection and upside potential. There are no monthly payments under FundMyHome but she has to bear in mind two points. Firstly, the buyer bears any losses of up to 20%. For example if the house price falls by 10% from RM300,000 to RM270,000, she will still pay RM300,000 for it. If she qualifies for a loan at the end of 5 years, her situation would be similar with a direct loan but with FMH having a big advantage of zero cash outflows over the 5 years.
However, if she doesn’t qualify for a loan, she would realise her losses which could be treated effectively as rental at low levels of losses, but which can become expensive at higher levels. If she is targeting a 2% rental yield, that is the per annum amount she doesn’t want her house price to fall beyond if she intends to walk away from the scheme after 5 years.
Secondly, if the property value goes up at the end of 5 years, she would have to pay the institutions all the gains of up to 20% capital appreciation before they start giving her the 20% share of the profits. Again any property appreciation between 2% and 4% p.a. translates effectively to more expensive rental. Conversely, taking a loan directly from the bank to buy the property would give her rights to 100% of any upside.
By the end of the fifth year, your daughter would have paid a total of RM132,960 under the mortgage arrangement which largely went to interest. With FundMyHome, she would have paid nothing beyond the initial RM60,000 unless the house price went up in which case she would have not only given up the capital gain advantage but also cough up more money and debt to secure ownership. After year 5, the amount already paid and balance payable to own the property would be RM351,739 under a bank mortgage against only 300,000 under FundMyHome, unless the house price went up in which case she would have not only given up the capital gain advantage but also cough up more money and debt to secure ownership. You are RM51,739 better off under FundMyHome, unless the house price went up in which case she would have not only given up the capital gain advantage but also cough up more money and debt to secure ownership. In fact, any property appreciation of between 3.5% - 4% p.a. for 5 years would wipe out the RM51k advantage altogether.
The FMH scheme under the so-called “free-lunch” scenario (see table below) sets your daughter back substantially in terms of net worth, net debt and future monthly mortgage compared to either renting or taking a bank loan as the table below shows. If the she had taken up a bank loan to buy the property, she would have enjoyed the capital appreciation and loan reduction. If she rented, she would have invested the 20% downpayment and the big difference between the rent and the mortgage payment raising net worth and reducing future net debt.
This is one counter-intuitive deal where your daughter loses money as her property value goes up. In financial jargon, she would have bought into a “butterfly option” from the institutions. This is a kind of derivative which allows your daughter to engage in a bet in which she hopes that her property price won’t move much. The best outcome for her is a price-neutral situation which would effectively give her 5 years free stay.
Alternatively, your daughter could assume a “no free lunch” stance under FMH illustrated in the table below in which she invests RM1,216 monthly which she would have otherwise paid to the mortgage. This is when FMH comes out better than either taking a mortgage or renting. However, this raises the interesting question of whether FMH is really making home-buying affordable when cash outflows have to be pretty high in order to make FMH come out ahead. Secondly, it still doesn’t derail the rent thesis since monthly cash outflows are much smaller and renting for longer term allows for higher-risk and higher return investing.
Which option would you choose for your child?