This letter provides further guidance on the Monetary Authority's policy on co-financing schemes in relation to residential mortgage lending. It supplements the guidance set out in my letter of 3 March 1995.
The essence of the Monetary Authority's approach towards co-financing schemes is that the lending bank should finance no more than 70% of the value of the property. The "top-up" element has hitherto been provided outside the banking system, by the property developer itself.
There has however been a recent example of a pre-arranged co-financing scheme where the top-up element has been provided by another bank, albeit in the form of a personal loan secured by a second mortgage. The Monetary Authority is concerned that such pre-arranged schemes may give the impression that the 70% loan-to-value guideline is being breached. The Monetary Authority believes that it is important to maintain the integrity of the guideline. There is also the point that the bank which is lending on the second mortgage may have little spare margin of security should property prices fall. Authorized institutions are therefore requested not to enter into arrangements to provide the top-up element in co-financing schemes whether or not it takes the form of a personal loan.
In general, institutions are encourage to consult with the Monetary Authority before entering into new types of arrangements involving residential mortgage loans.
A further aspect of co-financing schemes is that the property developer may offer terms which provide for an interest and repayment-free period of say three years on the top-up loan. This may be reflected in a higher price for the property. Where such an interest and repayment "holiday" is offered, the bank providing the residential mortgage loan should take immediate account of the future servicing costs on the top-up loan in calculating the debt servicing capacity of the borrower. In other words, the debt to income ratio of the borrower at the time of approval of the loan should be calculated as if there were no interest and repayment holiday. Where the price of the property has been increased to reflect such a holiday, the lending bank should apply a conservative valuation policy in determining the amount which it is prepared to advance.
I would be grateful if you would circulate this letter to the members of your Association. I am writing in the same terms to the Chairman of the Deposit-taking Companies Association.