Home loan

Why you shouldn’t pay off your home loan early, Money News

A common financial goal for Singaporeans is to become debt free. It’s a deep-rooted mentality that having any type of debt is terrible and should be avoided like the plague.

While getting out of debt can be an aspirational goal, many HDB homeowners tend to subscribe to the belief that it’s safe to pay off your home loan early – which, in reality, isn’t. necessarily true.

Public housing in Singapore is not exactly cheap. HDB apartment prices have increased by 13.37% over the past decade. At the time of writing, the average cost of a unit is $530,449, or $512 psf.

With a median monthly income of $4,680 in 2021, most Singaporeans take out loans to pay for housing.

There are several reasons why you can choose to repay your mortgage early.

Have peace of mind

Clearing your biggest debt is like lifting a big rock off your shoulders. Paying off your loan in full gives you peace of mind, knowing that you will always have a roof over your head. This gives you reassurance and frees you from worrying about monthly payments for years to come.

Pay attention to your finances

Another common argument for paying off your mortgage as soon as possible is to be able to dodge the interest that would otherwise have to be paid, which is 2.6% for HDB loans or around 1.7% for bank loans.

However, many don’t realize that a home loan is one of the debts with the lowest interest rates, which means you can easily get a return of over 2.6% if you invest it. money instead.

Suppose you have an extra S$100,000 in cash and you plan to put it into your HDB loan to pay it off sooner. However, let’s see what would happen if you invested it in an S&P 500 index fund instead, which gives an average annualized return of 7%, after adjusting for inflation.

Interest paid to HDB at 2.6%: $100,000 x 2.6% = $2,600
S&P 500 index fund investment return: $100,000 x 7% = $7,000
Potential missed gains: $7,000 – $2,600 = $4,400

As we can see from the calculations above, you could lose over S$4,000 a year if you chose to prepay your home loan instead of investing the extra money.

Note that this is an oversimplification and does not take into account other factors involved, such as market conditions and other risks associated with investing.

Moreover, by investing the money, you have the added benefit of liquidity, as you can freely cash in and make withdrawals at any time. This is not possible if you choose to redeem your HDB loan, unlike private properties where you have the option of taking out a home equity loan if you need cash.

ALSO READ: Should You Rush Your Home Loan Repayment Before Interest Rates Rise?

Not just any ordinary account

In case your savings are not in cash but blocked in your ordinary CPF (OA) account, investing in the S&P 500 index fund would not be possible. However, in this scenario, you can transfer the amount from your CPF OA to your CPF Special Account (SA), which would yield an annual return of 4%.

Instead of prepaying your mortgage, here’s how much you have to gain by transferring your money into your CPF SA.

Interest paid to HDB at 2.6%: $100,000 x 2.6% = $2,600
Returns from CPF SA: $100,000 x 4% = $4,000
Potential missed gains: $4,000 – $2,600 = $1,400

Potential gains would be even higher if you have a bank loan or choose to refinance with a bank, as interest rates are well below HDB’s 2.6%.

Interest paid to the bank at 1.7%: $100,000 x 1.7% = $1,700
Returns from CPF SA: $100,000 x 4% = $4,000
Potential missed gains: $4,000 – $1,700 = $2,300

One of the main disadvantages of transferring your money to your CPF SA is that it is irreversible, meaning you cannot transfer it to your CPF OA for your home loan payments if you need to do so at home. ‘to come up.

From the examples above, we can see that it is clearly better to invest your extra money than to use it to pay off your mortgage early.

Good Debt vs Bad Debt

Although our society may have taught us that any form of debt is a negative thing that we should avoid, it is essential to understand that not all debt is the same. For example, debts with high interest rates such as personal loans, credit cards and bank overdrafts could quickly drain your bank account and should therefore be avoided at all costs.

On the contrary, home loans tend to have low interest rates. As the examples above show, you could get a higher percentage return on your money if you invest it in other investment vehicles.

Also, if your home loan is from the bank instead of HDB, you will likely incur a prepayment penalty, usually around 1.5% of the prepaid amount. Banks impose it to compensate for lost interest.

ALSO READ: 3 essential things you need to know about fixed mortgage rates

Consider refinancing

A much better alternative would be to refinance your home loan. Refinancing is quite common among homeowners, where you replace your current home loan with a new loan from another bank after completing the lock-in period.

The benefits of refinancing include shortening your loan term and lowering your interest rate. In addition to this, many banks offer grants to cover legal fees or appraisal fees for you.

Suppose you have S$400,000 remaining on your outstanding HDB loan, with a remaining term of 20 years. If you were to continue this current loan, you would pay $2,140 in monthly installments for the next 20 years.

However, if you decide to refinance with another bank at 1.65% interest, your monthly payments would be reduced to $1,958, which is a savings of $182 per month or $2,184 per year.

That said, before deciding whether or not to pay off your home loan, be sure to read our list of the pros and cons of paying off your mortgage before the end of your term.

This article was first published in 99.co.


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