How do you know if you’re financially ready to buy a property?
Most people might just use a “gut feel” or some arbitrary benchmark – “30 years old already? Got a new job? Better buy a property!” – but let’s be honest – that’s hardly a sensible approach.
If you’re looking for a more structured and objective assessment method to assess how prepared you are to take the plunge, how about personal finance ratios?
Typically, financial ratios are simple “quick check” calculations analysts use to judge a company’s financial health more efficiently. In the stock market, for instance, the most common ratio is the price-to-earnings ratio.
In this guide, we are going to use the same principles and apply them to our personal finances with the goal of better gauging your financial readiness for a new home purchase.
We’ll be looking at four of the most useful ones. For each, we will show you how to calculate them, the financial implications, some ideal ranges, and how to think about them in the context of a potential property purchase.
Note: Obviously, the biggest question is – can you afford the downpayment (including the cash portion)? But once you’ve got that basic prerequisite, these four ratios can help you look beyond to see if you’re truly prepared to buy a property.
How to Save Up For Your Dream Home: A Budgeting Guide
Read more here.
6 Best Practices for New Homebuyers in Singapore
Read more here.
5 Important Considerations When Upgrading to A Bigger Home
Read more here.
1. The Liquidity Ratio: How Much Cash Do You Have?
How to calculate it: Your total cash balances (current accounts, savings accounts, fixed deposits, and cash management accounts) / Total monthly expenses
Your liquidity ratio tells you how many months of expenses your current liquidity reserves can cover. Now, because we are talking about these ratios in the context of whether you’re ready to buy a property, you should be looking at how this ratio (and the others) would change after you buy a property.
For example, a 30-year $500,000 mortgage at 2.0% annual interest would cost you about $1,850 in monthly repayments. What would your liquidity ratio be like after adding that on? You should also throw in a buffer on top of that for maintenance expenses. Don’t forget to account for the effect of the downpayment on your cash reserves as well.
After accounting for the potential purchase, the ideal range to be shooting for is 6 months to a year, with 3 months being the bare minimum. Remember that your liquidity ratio also tells you how long your emergency fund can last you in worst-case scenarios – such as losing your job.
That said, there is some leeway here, and the question to also ask yourself is – how quickly can you “replenish” your liquidity ratio? For example, let’s say your liquidity ratio will fall to under 6 months after you purchase a property. You should also estimate how long it will take for that ratio to go back above 6 months. The time it takes will largely depend on your savings ratio, which we discuss later below.
2. The Liquid Assets to Net Worth Ratio: How Much Cash Can You Easily “Unlock”?
How to calculate it: Your total cash balances (current accounts, savings accounts, fixed deposits, and cash management accounts) / Net worth (total assets minus liabilities)
Your net worth is the same as a company’s equity on its balance sheet. You determine it by taking all your assets (cash, investments, CPF, property market value) minus liabilities (outstanding debts including home loan). The liquid assets to net worth ratio tell you what percentage of your net worth is liquid – easily convertible to cash.
Why is this important? Because knowing this ratio can help you avoid falling into the “asset rich cash poor trap”, sometimes known as being “house poor”. The ideal range for this ratio is 15% and above.
Because of the downpayment, your cash reserves – and thus this ratio – might be affected. It also depends on how much of the downpayment you are planning to finance with your cash reserves versus your CPF OA balances. What’s important to consider here is that, if buying a certain property will cause your liquid assets to net worth ratio to dip significantly below 15%, it might be wise to consider something more affordable.
3. The Savings Ratio: How Much Savings Do You Have?
How to calculate it: Your total monthly savings / Gross monthly income
This one is straightforward. It sells you how much of your gross income you are putting aside for savings or investments each month. Although CPF acts as a “forced savings” mechanism, you should still shoot for at least 10% (a number advocated by the Financial Planning Association of Singapore) – even after taking on a home loan.
Tip: If you already have a mortgage but have been unable to hit your target savings ratio, you might need to optimise your cash flows. Refinancing can help.
4. The Total Debt Servicing Ratio (TDSR): How Much of Your Income Goes Into Paying Loans?
How to calculate it: Your total monthly debt repayments / Monthly take-home income
If you’ve done even basic research into home loans in Singapore, then you’ve probably heard of the Total Debt Servicing Ratio, abbreviated as TDSR. Because of MAS regulations, banks can only extend you a home loan if your post-home loan TDSR is lower than 60%. Also, this TDSR calculation will be made assuming an interest rate of 3.5% for the home loan.
A subset of the TDSR is the MSR – Mortgage Servicing Ratio, which is only applicable for HDB flat and Executive Condo (EC) purchases. This is calculated by taking your total monthly home loan repayments divided by your monthly take home income. MAS mandates that this cannot exceed 30%.
These are the “mandated regulatory” minimums. But they are far from ideal. For our purposes, we consider the ideal post-home loan TDSR to be under 40%. If you have higher-interest debt, it may be wise to pay that off first And again, if you currently have a home loan and you think the TDSR is higher than it should be, refinancing into a lower-interest mortgage may help.
Putting Everything Together – A Property Comparison Example
Now that we’ve gone over all four ratios, let’s see how we can put everything together. In the following tables, we give the hypothetical financial stats of “Mr Tan”, two properties at different price points, and how the four financial ratios would change for him for both potential purchases.
Note: You can use these ratios for a household as well.
First let’s look at Mr Tan’s current (pre-purchase) “stats”.
B
CPF OA Balances
$200,000
C
Non-CPF OA Balances (for net worth calculations)
$70,000
D
Total Debt
–
E = A+B+C-D
Net Worth
$325,000
F
Gross Monthly Income
$8,000
G
Monthly Take Home Income
$6,384
H
Monthly Expenses
$2,500
I
Monthly Debt Repayments
–
J
Monthly Savings
$3,884
K = A/H
Liquidity Ratio
22 months
L = A/E
Liquid Assets to Net Worth Ratio
17%
M = J/F
Savings Ratio
49%
N = D/G
Debt Servicing Ratio
0%
Obviously, Mr Tan is in pretty good financial shape, which is why he thinks he’s prepared to buy a property. But let’s now look at two potential properties he’s considering.
Property Price
$1,000,000
$800,000
Home Loan Amount (75% LTV)
$750,000
$600,000
20% Downpayment (Cash or CPF)
$200,000
$160,000
5% Cash Downpayment
$50,000
$40,000
Monthly Repayment
$2,772
$2,217
Here are the assumptions we will be making.
- Mr Tan will use as much of his CPF OA funds as possible for the downpayment
- However, he will not use his CPF OA funds for the monthly home loan repayments
- The potential home loan will be 30 years at 2% per year
- His cash reserves and CPF are his only current non-property assets
- The property price is also the current market value
- He is currently debt-free
Now, the most important part – assessing how Mr Tan’s financial ratios would look like depending on which property he chooses.
Total Cash Reserves (after paying 5% downpayment)
$5,000
$15,000
CPF OA Balances (after paying 20% downpayment)
–
$40,000
Non-CPF OA Balances
$70,000
$70,000
Total Debt (housing loan)
$750,000
$600,000
Net Worth
$325,000
$325,000
Gross Monthly Income
$8,000
$8,000
Monthly Take Home Income
$6,384
$6,384
Monthly Expenses
$2,500
$2,500
Monthly Debt Repayments (home loan instalment)
$2,772
$2,217
Monthly Savings
1,112
$1,667
Liquidity Ratio
2 months
6 months
Liquid Assets to Net Worth Ratio
2%
5%
Savings Ratio
14%
21%
Debt Servicing Ratio
43%
35%
As the table shows, the lower-priced Property 2 may be more suitable for Mr Tan. It would enable him to maintain a far healthier savings and debt servicing ratio, while his immediate post-purchase liquidity ratio would be more robust as well. His liquid assets to net worth ratio is still low, but that should steadily increase because of his higher savings ratio.
Remember, this is just an example to demonstrate how you can use these ratios for yourself. These are of course not the only factors that go into determining whether you are financially ready for a property – but they certainly can help. Another useful thing you can do is to use our Mortgage Affordability Calculator to help refine your options.
Affordability Calculator
Estimate what you can comfortably spend on your new home
Article title
Lorem ipsum dolor sit amet, consectetur adipisicing elit, sed do eiusmod tempor incididunt ut labore et dolore magna aliqua.
Need More Personalised Home Financing Advice and Recommendations?
The great thing about using financial ratios is that they are automatically tailored to your situation. But sometimes, you may want to go even more personal, and perhaps even ask a few questions of your own.
Our Home Financing Advisors have you covered. Just head over to this page and fill out the short form and one of them will get in touch with you. For more information on everything home financing, check out the rest of our guides.
Chat with us on WhatsApp
Fill up an online form
This article was written by Ian Lee, an ex-banker turned financial writer who hopes to use his financial background and writing skills to help raise people’s financial literacy levels – a necessity in our modern world.
Disclaimer: The information is provided for general information only. PropertyGuru Pte Ltd makes no representations or warranties in relation to the information, including but not limited to any representation or warranty as to the fitness for any particular purpose of the information to the fullest extent permitted by law. While every effort has been made to ensure that the information provided in this article is accurate, reliable, and complete as of the time of writing, the information provided in this article should not be relied upon to make any financial, investment, real estate or legal decisions. Additionally, the information should not substitute advice from a trained professional who can take into account your personal facts and circumstances, and we accept no liability if you use the information to form decisions.