Here’s a hypothetical scenario: Max is currently 25 years old and earns a monthly salary of RM3,000. He recently came across a unit close to his workplace, located next to a LRT station and shopping mall.
It is 600 sq ft with an asking price of RM230,000. Similar properties range between RM1,000 and RM1,300 a month.
As a first home buyer, what are Max’s options for obtaining this property? How much initial outlay is required, and are “zero down payment” plans an option?
Initial capital
Assuming this unit is a residential property, Max, as a first-time home buyer, would be required to place a 10% down payment, pay for different types of transaction costs, and set aside some cash for renovation and refurbishment.
To be safe, he would also need at least 12 months worth of mortgage payments set aside. Hence, the initial capital outlay for this unit would be about RM60,000 to RM70,000 in cash.
Whither zero down payment?
Let’s say Max agrees to purchase this unit. He would state RM230,000 as its official transaction price in the sales and purchase agreement (SPA), which would allow him to obtain a mortgage amounting to 90% of the unit price, or RM207,000.
He could, however, convince the seller to inflate the SPA price – say, RM260,000 instead of RM230,000. This would allow Max to apply for a mortgage of RM234,000 – in essence, allowing him to purchase the property with “zero down payment” (ZDP).
To achieve this “illusion”, Max would first need to pay 10% of the inflated SPA as his down payment, which works out to be RM26,000. He would also need to pay higher legal fees, stamp duties, and mortgage payments based on the inflated price.
Once the mortgage is disbursed, he would then have RM26,000 returned to him in the form of a “rebate”, thus completing the illusion. The thing is, one needs more money – and must agree to incur more costs – to pull this off.
Is Max considered smarter if he were to use ZDP to buy this unit? Well, he should consider the following:
1. Financial burden
The mortgage for the unit would be RM800 a month without ZDP, or RM900 with ZDP. His estimated property-related expenses would likely be about 30-35% of his monthly salary of RM3,000.
While he could rent out the unit for over RM1,000 monthly, he might fail to secure tenants or obtain consistent rental income.
Regardless, Max would still be required to pay his mortgage and other expenses. If he has other loans, his failure to generate income from the property will only add to his financial burden.
2. Outstanding loan
What if the price of Max’s unit were to fall to RM200,000 in the future? If he purchased the property with ZDP and a RM234,000 mortgage, he would end up owing the bank an amount greater than the value of his property.
In other words, if his outstanding mortgage were to stand at RM225,000 and he sold the property at RM200,000, he would need to fork out another RM25,000 to fully settle his loan.
3. Legitimacy issues
The third thing to consider is whether ZDP is a legitimate method of purchasing property. If Max were to fork out the 10% down payment, he could own the unit legitimately. Why bother going through the process of a ZDP and get himself caught up in a potential legal issue?
He could, instead, use his wits to increase his financial wealth and raise his income.
At the end of the day, Max should build his finances first and not rush as he is young. It’s good to start thinking about property investment at a young age, but it could be detrimental if it were pursued hastily without the proper knowledge and financial capability.
This article first appeared in KCLau.com. Ian Tai is a financial content writer, dividend investor, and author of many articles on finance featured on KCLau.com in Malaysia, and ‘Fifth Person’, ‘Value Invest Asia’ and ‘Small Cap Asia’ in Singapore.