1) Is it safe to set up Xbox Live in Malaysia using Singapore as your location?
Yes it is safe. But you need to have a valid singapore post code. I am using Singapore location on my last console then I realize it is not necessary so my new console I set using MY. If you thought singapore might have more player then you don't need to worry cos you can change the location anytime from the setting. I always play with Japanese on SSF4:AE

2) How's the connection in the games lag or smooth? such MW3,BF3 and such
If line smoothness is your concern the you definitely need to get Xbox as XBL is far far away better than PSN but you need to pay. Around RM180/year

3) Can i buy DLC games and such even though i live in Malaysia but set it up as Singapore?
Yes you can. But you need to have singapore credit card. But you can buy MS point from outside using MY credit card and redeem via XBL

4) What if i dont have credit card, how do i buy the DLC?
Buy MS point from 3rd party like playasia

5) Do i get any warning from Microsoft for faking location and such?
Not sure. So far I don't get any warning on my previous console.

Good luck bro.