While a business term loan is heavily tied to your past business performance; restricting you in terms of your loanable amount and interest rate, backing your loan with a property might offer you substantial freedom and savings. These apply to private properties only (non-HDB) which includes residential, commercial & industrial properties.
This is because properties act as additional way-outs for lenders who can rely on them as a repayment source. In a property-backed loan, your loanable amount can be extended up to 90% of the property valuation (for residential) and interest rates can go as low as under 1.6% p.a which is much cheaper than the typical working capital loan offered by a bank to small businesses at 6-7% p.a. effective interest.
Take for example, a business who started for less than a year with sales of $100,000 at breakeven. If he needs to get a loan to finance a won contract, he is likely to obtain a maximum loan of up to 2-3x of his monthly revenue ($25,000 -30,000) at higher interest rates. Furthermore, because his company is less than 1 year old, it is likely that he does not qualify for many banks. Hence, a property-backed loan might help him circumvent these restrictions to obtain financing.
Another reason to get a property-backed loan is when you consider the opportunity cost of holding a fixed asset. Properties are stored valued assets that rely on the market to drive its return. While the property market in Singapore has proven to be robust, cooling measures in the housing market and weaker commercial rents may dampen property prices in the medium term. As such, an equity cash-out might prove to be a more effective way to finance higher return projects. With good planning, financing rates could reach be as low as under 2% p.a. in the next 2-3 years. That is an excellent cost of funding for any business.
How much you can cash out depends on a mixture of 3 key factors, namely, (1) loan-to-valuation (LTV), (2) outstanding loan amount and (3) total CPF funds used if any. Of course, you might be subject to other general regulatory limits like total debt servicing ratio (TDSR) if you take a loan as an individual. But if you take it as under a business, you will need to provide evidence on your cashflow to support your monthly instalments. Do note that an individual can offer his residential property as a 3rd party mortgage for a business loan.
(1) Loan-to-valuation (LTV)
The LTV is calculated as the maximum loan a lender can provide over the valuation of your property. For example, a 70% LTV on a $1 million property means the maximum loan amount you can take is $700,000. Therefore, the higher the LTV, the more you can cash out. See below LTVs for different property types.
(2) Loan outstanding and total CPF used
With the LTV, your total cash out amount is now the % LTV of your property value minus your outstanding loan and the CPF used to purchase the property (with accrued interest). This is because the loan taken will be first used to redeem the loan from your existing financier to release its existing charge. Also, this means that if your property is entirely paid by CPF, there is nothing left for you to cash-out.
Of course, if the property is fully paid, these restrictions do not apply any longer.
Here’s an example:
George has a condo currently valued at $1 million with an outstanding loan of $300,000. His has also utilised a total of $100,000 including accrued interest to finance his condo from his CPF. This means his maximum amount he can cash out is [LTV 70% x S$1,000,000 (market value)] - $300,000 (outstanding loan) - $100,000 (CPF Utilised) = $300,000.
Generally, banks are the most straight forward option. They are priced competitively and offer tenors of up to 25 years. However, the cons are in their restrictive lending policies which may include stringent credit assessment on the business and lower LTVs. For individuals, many people find it difficult to obtain a substantial cash out amount with the recently reduced TDSR as this means that your monthly repayment cannot exceed 55% of your gross income.
As such, non-bank lenders do offer alternatives such as interest servicing only options and can stretch LTVs up to 90%. For taking on the additional risk, many lenders do charge a higher fee both on processing as well as on interest. Therefore, it is essential that one weighs the total cost against the benefits of the funds. Below is quick table showing the contrast between the two lender types.
As you can see, while banks are much cheaper in terms of pricing, a non-bank option offers a wider range of flexibility. This includes a higher LTV, and interest servicing only option. This may be a deciding factor as an interest servicing only option greatly reduces your monthly repayment and increases your cash flow. However, as interest cost tends to double, most loans are no more than 3 years in tenor and are refinanced to back to banks. As such, should you take a loan with a non-bank, you face a risk of not being able to qualify for a bank refinance and having to be stuck with a higher interest rate. This is something that borrowers need to take note.
Property-backed loan is an option that a business owner should consider when thinking about financing. While it can help you obtain a larger loan quantum at a cheaper interest, one must be careful not to overleverage. At the end of the day, a debt still needs to be paid and the effective use of your funds will help you steer clear of losing your property.
Leading digital loan marketplace Lendingpot connects SMEs to its network of 45 lenders comprising relationship managers from banks, financial institutions, and private and peer-to-peer lenders in Singapore for free. It aims to help SMEs overcome the information asymmetry problem and lack of transparency prevalent in the SME financing sector by offering SMEs financing options such as business term loans, property loans, revenue-based financing, credit lines, working capital loans, bridging loans, invoice financing, and more.
Benjamin heads up Lendingpot with a background in all things SME. He was previously a commercial banker at Citi with experience in Relationship management, Credit Risk, Trade Operations and Corporate FX sales; and understands the difficulties SMEs face in this opaque world of SME financing.