Second Mortgages and Stress Testing: Practical Guidelines for Borrowers

Second Mortgages and Stress Testing: Practical Guidelines for Borrowers

Requirements and Application Fees for Second Mortgages and Stress Testing

The real estate market in Hong Kong has always been highly active. When purchasing a property, buyers typically need to apply for a loan from a bank to pay for the purchase. Generally, buyers need to pay a down payment of 20% and then apply for a first mortgage from the bank, which can lend up to 60% of the property value. In addition, some developers offer "second mortgage plans" that allow buyers to borrow a portion of the loan from the developer to purchase the property. However, when approving loans, banks conduct stress testing to determine whether buyers have the ability to repay. This article explains how banks conduct stress testing and how buyers can apply for a second mortgage.

What is stress testing?
During stress testing, banks assume that interest rates will rise to 3-5%, to determine whether buyers have the ability to repay at these rates. If buyers cannot repay at these rates, the bank will not approve the loan.

How is stress testing calculated?
When calculating stress testing, banks use the best mortgage interest rate as a basis and increase the interest rate by 3-5% to determine whether buyers can repay. If buyers apply for a loan beyond the first mortgage, the bank also needs to calculate the stress testing for the second mortgage. The bank uses the second mortgage interest rate as a basis and increases the interest rate by 3-5% to determine whether buyers can repay. Buyers must be able to withstand stress testing for both the first and second mortgages in order to obtain a loan.

How to apply for a second mortgage?
Buyers must apply for a second mortgage loan in writing through a financial company at least 60 days before the payment balance due date. Buyers need to provide sufficient documents to prove their ability to repay, such as a "credit report", "income proof", and "bank records" required by the financial company. The legal documents for the second mortgage loan are generally handled by the developer's representative lawyer, but buyers need to pay relevant lawyer fees and miscellaneous expenses. If buyers choose to hire their own lawyer, they need to pay the second mortgage lawyer fees and miscellaneous expenses themselves. In addition, some developers require buyers to pay a handling fee, and the related fees may not be refundable. Therefore, before applying for a second mortgage, buyers need to confirm all the costs and calculate whether they have the ability to pay these fees.

Example:
Suppose a buyer purchases a property for HKD 8 million and intends to pay a 20% down payment, apply for a 60% first mortgage, and apply for a 20% second mortgage from the developer. The first mortgage interest rate is 2.5%, and the second mortgage interest rate is 2.5% for the first 2 years and 5% for the next 23 years. The longest repayment period is 30 years and 25 years, respectively. If the interest rate rises to 5.5%, how much income does the buyer need to pass the stress test?

Applying for a 60% first mortgage is equivalent to a loan amount of HKD 4.8 million, with a monthly payment of HKD 18,966. After the interest rate increase, the monthly payment is HKD 27,524, and the buyer needs an income of HKD 45,873 to pass the stress test.

Applying for a 20% second mortgage is equivalent to a loan amount of HKD 1.6 million. The monthly payment is HKD 7,178 for the first 2 years and HKD 9,190 for years 3-25. After the interest rate increase,

the monthly payments are HKD 9,825 and HKD 12,195, respectively. The buyer needs an income of HKD 20,325 to pass the stress test for the second mortgage.

Therefore, the buyer needs an income of HKD 66,198 to pass the stress test for both the first and second mortgages. Buyers must be able to handle this stress in order to obtain a loan.

Conclusion
When applying for a loan, buyers must understand how stress testing is calculated and confirm whether they have the ability to withstand stress. In addition, applying for a second mortgage requires paying related fees, and buyers need to calculate whether they have the ability to pay these fees. Only after confirming the ability to handle stress and pay fees can buyers successfully apply for a loan.