Because it devalues a currency over time by raising the prices of goods and services, inflation affects loan maturities – even home loans.
Singapore’s core inflation accelerated to 3.3% year-on-year in April from a previous 10-year high of 2.9% in March, official data showed on May 23, due to rising energy and food costs.
Now you might be wondering how important inflation is to loan repayments and how you can use this knowledge, especially with big ticket items like mortgages.
Inflation can help borrowers
If wages rise with inflation and the borrower already owed money before the inflation happened, the inflation benefits the borrower. This is because the borrower still owes the same amount of money, but now he has more money in his paycheck to pay off the debt. This translates into less interest for the lender if the borrower uses the extra money to pay off their debt sooner.
When a business borrows money, the money it receives now will be repaid with the money it earns later. A basic rule of inflation is that it lowers the value of a currency over time. In other words, money now is worth more than money in the future. Thus, inflation allows debtors to repay lenders with money that is worth less than when they originally borrowed it.
Inflation can also help lenders
Inflation can help lenders in several ways, especially when providing new financing. First, higher prices mean more people want credit to buy big-ticket items, especially if their wages haven’t increased, which equates to new customers for lenders. On top of that, the higher prices of these items earn the lender more interest.
For example, if the price of a television goes from $1,500 to $1,600 due to inflation, the lender makes more money because 10% interest on $1,600 is higher than 10% interest. interest on $1,500. Plus, the extra $100 and any additional interest could take longer to pay off, which means even more profit for the lender.
We now know that inflation affects loan repayments, but lower and middle class households are often more negatively affected by inflation than upper middle class families and extremely wealthy households.
There is a piece of conventional wisdom when it comes to mortgages in that you pay them off whenever you have cash available in order to finish paying off the home loan sooner. However, the opposite might ring true if you factor in the inflation factor.
Simply put, the Singapore dollar 30 years ago is worth more than a Singapore dollar today due to inflation. By the same logic, a Singapore dollar today would obviously be worth more than a Singapore dollar 30 years from now.
This means that by repaying your home loan installments in advance, you will be using Singapore dollars which will be worth more for years to come.
So, wouldn’t you be a loser by paying more than necessary, despite the shortening of the term of your loan?
Of course, the only major argument against this logic is that while you might save money by outsmarting inflation, you’d end up paying more anyway due to the huge interest charges over the years.
A loan, whatever it is, is a debt that one generally wishes to repay as soon as possible (preferably to repay early, that is to say to pay before the due date). However, a home loan should not be considered the same as a personal loan, car loan, etc.
A home loan offers a number of advantages that may make prepayment unfavorable, even if inflation affects loan payments.
Home loan prepayment, or what some call prepayment, is a facility that allows you to pay off your home loan (in part or in full) before the end of your loan term.
Usually, customers opt for prepayment when they have excess funds. But you need to think again before prepaying a home loan and consider some important factors before deciding to prepay your home loan.
Before you consider prepaying your home loan, you should ensure that you have sufficient funds for your financial goals such as marriage, overseas travel, etc. Therefore, you run out of funds when you need to achieve a financial goal. Additionally, you should also ensure that you have excess funds for medical emergencies or unforeseen events such as job loss.
INCOME FROM INVESTMENTS
The cost of prepayment should also be weighed against the returns that can be obtained from the investments. If you have the potential for higher returns than the interest on the home loan, it is better to invest the excess funds rather than using them to prepay your home loan.
A home loan is a long-term loan; In order to “apples to apples” the cost of your home loan against a comparable investment, an equity investment should be considered. Investing in stocks is a long-term investment where the risk decreases in proportion to the duration of the investment, i.e. the longer you hold your investment in stocks, the lower the risk will be.
Often, investing excess funds is more successful than prepaying a home loan, even if inflation affects loan maturities.
The main advantage of prepayment is the reduction of interest outflows. The interest component is highest during the initial phase of the home loan. Therefore, prepaying mid-to-late-stage loans may not give you the full benefit of saving on interest. In such cases, it is prudent to invest the excess funds.
Home loans are easier to manage – the interest rate on home loans is usually lower than the interest rate charged on other loans such as personal loans or credit card loans. Therefore, if you want to reduce your debt, it is better to prepay loans with high interest rates (as opposed to home loans which carry a lower interest rate).
PENALTIES FOR EARLY REDEMPTION
The reason most homeowners don’t prepay their home loans is due to penalties imposed by lenders for prepayment. Always check your loan agreement to make sure you’re not paying unnecessarily to repay a loan in full, when you can save money by simply leaving that money in your savings account.
Mr Paul Hochief officer at iCompareLoansaid: “It’s always a good idea to check with a loan specialist if your home loan early redemption is worth it. They will be able to give you the best advice. »
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