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I HAVE previously written about why a home is your best investment. Suddenly, the topic has become hot. I will tell you why shortly.

As you know, there are only two choices for investing your money: Debt and Equity.

Debt is when you lend money, like buying a fixed deposit. It is the same as lending money to a bank. Returns are low but so are the risks.

Equity is when your investment gives you ownership, like stocks or property. It comes with high returns and high risks.

A home is a special type of equity. It gives high returns with low risks. This is because of 'imputed rent'. It means that if you didn't own a flat, you would rent one.

It is like playing a new game: Subsidised 4-D. Say that you have a $50 a week 4-D habit. It won't take long to rack up big losses.

But if someone pays you $40 every time you bet $50, it changes everything. Then, the risk of loss drops considerably and 4-D becomes a good investment.

Imputed rent works the same way. The subsidy you receive is the rent you would have paid if you did not own a home.

Beside that, home ownership forces regular savings, charges low interest rates and amplifies returns through leverage (borrowing). There is also a 'fun factor' that you don't find in boring old shares.

MORE RISK THAN YOU THINK?

On 3 Jul, The Straits Times ran a front-page report 'Housing loans eating up funds for retirement.'

It told of people who had been retrenched. They didn't have money in their CPF ordinary account (OA), defaulted on their home loan and were forced to sell at a loss.

The CPF Board's solution is for them to buy a smaller home. Then they can keep a safety cushion of money in their CPF account.

I used to think it was a problem that takes care of itself since banks and HDB don't allow you to over-borrow. Their rule is your home loan payments may not exceed 35 per cent of your income.

New CPF data reveals that nearly one out of every four CPF members uses 35 per cent or more of his income to pay mortgage. It is a shock. It seems the bank and HDB rules have been circumvented.

What do you do? If your home loan interest rate is rising but your income is not, you could be over-extended.

It is too late to downsize your home, so I advise you to cut back immediately on other debts and long-term investments.

When calculating your home loan payments as a percentage of your income, be sure to do it properly. For joint owners, use the total household income of both owners, like you and your spouse.

If your home loan payment is less than 35 per cent of your household income, then don't worry. You are not over-extended.

Big question: Did CPF Board divide home loan payments by individual rather than household income?

If so, it explains why such a large number of CPF members appear to be over-stretched on their home loans. If this is what happened, we can relax. It is a simple statistical aberration.

On the other hand, if household income was used as the denominator, then it could be a problem, particularly if we see that home loan default rates have also spiked higher. It calls for quick action by banks and HDB to tighten lending policies.

How to build a CPF cushion

The CPF Board suggests members keep a cushion in their CPF account in case of emergencies. Here are two ways to do it:

1) Do not pay down your home loan as it reduces your CPF cushion and it saves you very little money.

It is because HDB charges 2.6 per cent for a concessionary rate loan and the CPF OA pays 2.5 per cent interest. The difference is just 0.1 per cent which comes to just $1 per year for every $1,000 of home loan.

That is all you save when you use your CPF money to pay down your home loan. Think of it as home-made insurance against defaulting on your home loan.

2) A second way to keep a CPF cushion is to 'dodge the HDB bullet'. When you purchase an HDB flat, HDB will take all the money in your OA and apply it to your downpayment. You can avoid this fate through an 'unofficial opt-out scheme'. How? First, calculate how much money is in your OA in excess of the required 10 per cent downpayment.

Then transfer that amount into a fixed deposit at a local bank. Do it just prior to your second HDB appointment. After the appointment, sell the fixed deposit and transfer the money back into your CPF account.

HDB does not encourage this or even explain it. Is it useful to educate CPF members on how to do it? I think so.

An even better idea might be to make the excess downpayment an opt-in rather than an opt-out scheme. The CPF members who are currently ignorant on how to opt-out may be the ones who need a CPF cushion the most.

DR MONEY'S QUICK QUOTE

One of the strangest things about life is that the poor, who need money the most, are the very ones that never have it.
- Finley Peter Dunne