In mid February 2020, we woke up to a peculiar sight in our garden. Out of nowhere, a family of geese suddenly appeared, wandered about the garden then marched down the driveway out of the house, leaving droppings (but no golden eggs) along the way. The family moved in a perfect line, with one parent leading the way, and the other bringing up the rear.
We had never seen anything quite like that before. We don't live anywhere near a kampung nor a farm, so where did the geese come from? What motivated them to waddle right through our place?
As strange as it might sound, the gaggle of geese in one straight line resonated with my thoughts that we had to get our ducks in a row, to fortify our war chest so we can be ready in the event of a major market correction.
I'd explained my rationale for sitting out the roller-coaster markets in my last post. The market takes time to reach the bottom in each recession. When the dotcom bubble burst, the Nasdaq tumbled 78.4% from its peak to bottom in two and a half years, whilst the S&P 500 slipped 49% over the same period. During the Global Financial Crisis, the S&P 500 lost 57% over the course of one and a half years.
The market does not fall from peak to bottom in a straight line. Rather, it goes through many rounds of ups and downs over a period of time before hitting the true bottom. The S&P 500 hit a record peak of 3,386 points on 19 February 2020, before COVID-19 fears accelerated a drastic 35% decline to 2,191 points on 23 March 2020. Although a V-shaped bounce has since occurred, logic and common sense tells me that the severity of the damage which COVID-19 has done to the global economy cannot possibly be over. A short-term bottom may have come and gone, but the market will still have to run its course in a recession of this scale and magnitude.
We've been marshalling our ducks into a row, as we play the waiting game. The steps which we've taken thus far are as follows:-
No. 1: Cutting back on expenses to increase our savings.
For the last few months, we've been preparing most of our meals at home, instead of eating out, taking out or ordering in. We've also saved on transport as we hardly go out anymore.
I compare prices online before ordering necessities, and use cashback apps and coupons for greater savings.
We've also not done any travelling this year. It's hard to believe that the mid-year school holidays have already come and gone.
No. 2: Moving funds to higher interest bearing bank accounts.
Details on interest rates of various banks can be found at Showdown on Premier Banking Accounts and Best Place to Park S$2 Million for 3 Months. Do check with individual banks on the latest rates though, as various banks have been acting to slash their deposit interest rates of late.
No. 3: Raising funds by selling non-performing and under-performing assets like an extra car or motorbike, boat, club membership etc.
I had a car which reached its 10th year last May. I renewed the COE for 10 years and kept the car as a spare. The car was well looked after over the years, and its paintwork was as good as new. After investing in new half-leather seats, we sold the car for a healthy profit in February 2020.
Hubby reluctantly parted with his some of his Big Boy Toys as well, adding more to our war chest.
No. 4: Obtaining an investment and personal credit lines at low interest rates.
Margin trading lines and personal credit lines are offered by banks and brokerages, but they attract high lending rates.
Premier and private banking customers have access to preferential lending rates for investment and personal credit lines. The rates are available at 1-month SIBOR plus spread, which works out to be 0.85% at the moment for me. There are minimum assets under management ("AUM") requirements to open such accounts, but shares, unit trusts and bonds which one holds can be transferred to the bank to form part of the AUM when opening such accounts.
The bank relationship manager may require customers to sign Accredited Investors declarations before setting up such lines. Collateral may be required too, for instance, a sum placed in fixed deposit.
Interest is only payable for such lines when money is withdrawn. When the funds are not in use, they cost nothing, making such lines an ideal war chest.
No. 5: Looking into the possibility of unlocking equity in our property by gearing up.
A property of ours was nearing the end of its mortgage lock-in period. As its value had appreciated since our purchase, we looked into the possibility of unlocking some of its value without selling the property. If we could unlock its value this way, it would boost our war chest even further.
The most obvious way of unlocking equity this way is to approach the bank for one of 2 types of loans. The first is a property equity financing line, and the second is an overdraft facility. Both lines will have to be secured by the property. Most banks offer property equity financing lines, but overdraft facilities of this nature are harder to come by and are likely available only at certain private banks and not all.
When you express your interest in either of these loans, banks will start by giving you a desk-top valuation of your property. They will also let you know what percentage of the value they're able to lend. Some banks are willing to lend up to 70 to 75% of the value of the property, whilst others will not go beyond 50%. To borrow above 50% of the value, Total Debt Servicing Ratio ("TDSR") will apply. MAS has clarified that TDSR does not apply if the loan does not exceed 50%.
Illustration of How Property Equity Financing can Boost your War Chest:
Bank Valuation of Property = S$3,000,000.00
50% Property Equity Loan = S$1,500,000.00
Less Outstanding Mortgage Loan = S$500,000.00
Money Available for War Chest = S$1,000,000.00
Given the current grim economic climate, banks have started to take a much more conservative view of property valuations in recent months. I was told by one mortgage specialist that valuations have come down a fair bit, especially outside the Core Central Region.
When applying for property equity financing, banks will require the applicant to submit income documents and make declarations of his outstanding loans eg. mortgages, car loans, etc. This is regardless of whether TDSR applies as banks will still need such information to assess the applicant's ability to make monthly installment payments to them. The interest rate payable for such loans are the same as any other mortgage loans. The borrower can choose between fixed or floating rate packages, 2 or 3-year lock-in periods, etc.
Once the loan is approved, the full amount will have to be drawn down within a specified time. Some banks require it to be done immediately, whilst others give borrowers up to 6 months to do so. Once the loan amount is released by the bank, interest will be payable. If the borrower does not draw down on the funds within the specified time eg. he no longer needs the funds, a penalty of 1 to 1.5% of the loan quantum will be imposed.
At first glance, this method may not seem so ideal for creating standby funds for a war chest, but if the funds are withdrawn and placed in an interest-bearing account which pays a higher rate of interest that the lending rate you're paying the bank, it's actually possible to make money from arbitrage. If deposit interest rates (eg. 0.8%) are not higher than the mortgage rate (eg. 1.25%) you're paying, you'll effectively only be paying the difference between the 2 rates (eg. 1.25 - 0.8 = 0.45%) for having a pool of funds at your disposal, as you await opportunities in the market. For savvy investors who're confident of making profits, paying such interest will be worthwhile.
The second method of unlocking equity without selling a property would be to obtain an overdraft facility secured by an unencumbered property. Interest rates for such overdraft facilities will be higher than regular mortgage interest rates, but no interest is payable if no funds are withdrawn. There is also no lock-in period. As our property is not unencumbered, we had to rule this option out.
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