Every property owner with a home loan in Singapore must have had the perennial question lingering when it came to their mortgages – to pay down or not? There are various factors to consider when thinking about how to tackle this age-old issue but a few simple points as detailed below can help to provide clarity.
Did You Know? According to OCBC Bank’s latest Financial Wellness Index 2020 survey, 55 per cent of millennials (aged 21-39) are concerned about not being able to afford a house for their own stay. Almost 38 per cent (four in 10) individuals who already have mortgage loans have problems paying off loans on time.
Prepaying for your home loan has some benefits. Prepaying loans itself is like investing. Aside from saving money on your interest payments, prepaying your housing loans helps diversify your investable funds. You can use the saved amount in varied investments, which will help to generate an assured income. Furthermore, if you sell your house, it frees up part of your accrued interest.
In simple terms, prepaying your mortgage means that instead of diligently servicing your mortgage payments every month, you pay a partial or full loan amount beforehand.
Let’s understand this with the help of an example. Suppose you have a mortgage of $500,000, with an interest of 2.5% and a remaining loan tenure of 20 years. Also, you have spare cash of $50,000. Now you have to decide whether to use the spare cash and pay down the mortgage early or invest this amount in other assets (like bonds, stocks, etc.) at a yield of 3.5% per annum for 20 years.
Total saved over 20 years: $63,600
Total earned over 20 years: $85,000 (including principal)
The clear winner is apparent: if you have an investment option which gives higher interest than your mortgage, it is always a good idea to invest rather than paying down your mortgage loan.
Furthermore, when you lock up all your wealth in a single asset, like your property, you are at greater risk during a down-cycle in the property market. It is another reason not to use all your cash to pay off your home loan mortgage early.
By paying your home loan early, you would reduce your outstanding loan balance and hence, eliminate interest payments. It will reduce the amount of cash required to meet your monthly expenses, thus helping you save significant money every month.
Let’s discuss an example assuming that you have accumulated the right amount of savings and would like to settle it towards paying off your mortgage.
Let’s say, you took a home loan of $500,000 for 20 years. You would be paying a monthly instalment of $2,649.
If you consider making a one-time payment of $30,000 against your home loan mortgage, you pay $2,249 every month.
It would save you around $160 (= $2,649 – $2,249) every month, which accumulates to a sum of $38,400 over 20 years. That money that goes into your pocket instead of the bank!
Therefore, YES, it is worth paying your mortgage early if you have spare funds without any good utility.
If you are looking to buy a second property and currently servicing your first home loan, the maximum loan amount you could borrow plunges to 45% of the property price only. In such a situation, you may want to pay off the outstanding home loan first so that you don’t have to put away a large portion of cash while paying the initial downpayment.
Some homeowners may have debt anxiety and probably think about how great it will feel to be mortgage-free. If you are uncomfortable with the idea of having debt, paying off the mortgage early might help you ease the anxiety and feel exceptionally liberating. However, you must work out whether doing so will be a sensible financial decision before taking action.
If you are left with little savings after paying off your mortgage home loan, it might not be a good thing to do – irrespective of how calm and relaxed you might feel afterwards.
Now that mortgage interest rates are way above the 2.5% CPF OA savings rate, should you still consider prepaying your home loan?
This question is especially relevant for those using their cash reserves to make their monthly repayments and stash away their CPF savings to earn compounding interest at 2.5% for retirement. Now that mortgage rates are shooting over 3.5% here in Singapore, in most cases, it does not make much sense.
Those using cash to prepay their outstanding mortgage when mortgage rates are more than 2.5% should ask themselves if they have got any investment options with returns higher than current mortgage rates at least to use their spare funds.
We know interest rates go through cycles of peaks and troughs. Even though interest rates are going high now, they are not going to stay high forever.
Here’s an interesting example that shows how paying off your mortgage early with your savings can affect your financial situation.
Suppose you have a remaining home loan of $250,000 and have $250,000 in cash.
Your net position is: ($250,000 cash) – ($250,000 debt) = $0.
If you have repaid the entire home loan, your net position becomes: ($0 cash, since you have paid the whole loan amount) + ($0 debt) = $0.
Though your net position in both cases is the same (net position: $0), you were in a better financial condition in Case I. Why? It is because you have the power of cash in your hands, which you can use for emergencies and opportunities.
In Case II, even though you have zero debt, you are left with zero cash, which could lead to liquidity problems if you run into a crisis.
In a crisis situation, you could be forced to sell your home or use alternative high-interest lines of credit like personal loans. This could end up being far more expensive than any average mortgage loan.
If you need cash on hand in the future, you should consider taking up a home equity loan, as it comes with the lowest interest.
Although making a lump sum payment towards your home loan does have its benefits, there are some situations where it might not prove to be your best decision. If paying your loans early will deplete your savings, you should not hasten to pay off your housing loan. It is not a very good idea to spend all your cash on a housing loan and tie yourself up financially because it is hard to convert equity from your property into cash in times of unexpected financial challenges, such as a loss of income or a medical emergency.
Also, it might not be wise to prepay your mortgage loans with relatively low interest rates when you have other debts with higher interest rates, such as credit card debt.
Similarly, if the penalties imposed by your bank for an early prepayment negate interest savings gained by paying your loans early, you might not want to go for that option.
*Note that some home loan packages will waive this penalty completely or at least limit the maximum penalty amount. Read the mortgage terms and conditions carefully before going ahead.
Mortgage insurance is another reason to think twice before prepaying your mortgage loan. If you are covered under mortgage insurance like Mortgage Reducing Term Assurance (MRTA) or Home Protection Scheme (HPS) for HDB properties, your outstanding home loan will be paid off in situations like death, terminal illness, or permanent disability. Thus, the extra savings you have accumulated will help you support yourself or your loved ones when needed.
However, if you are not insurable and are the only wage-earner in your family, paying off your mortgage aggressively could be a good idea. It will leave you with a small amount of outstanding debt if anything unfortunate happens to you.
The current home loan mortgage rates offered by banks or financial institutions are much higher than the 2.5% CPF savings rate to earn compounding interest. To take advantage of such a situation, some homeowners may want to use CPF monies to prepay their home loan mortgage and save money on mortgage interest payments. While it might make sense in the short term, it may not work in the long run.
When you prepay your home loan early thinking about high interest rates now, you are missing out on the fact that mortgage rates will not stay high forever. It is not economically feasible. So, when interest rates will eventually come down below 2.5% or the prevailing CPF savings rate, you might not be able to take full advantage of the situation.
When you borrow money from your CPF OA account to prepay or pay off your mortgage, you are still borrowing – from your future self, rather than from a bank. It is because you are liable to return that sum, along with the accrued interest earned, from your sales proceeds when you sell the property.
When you replace your existing home loan with a new home loan from another bank, it is called refinancing. In Singapore, home loan refinancing is quite a popular financial move by borrowers, mostly after the lock-in period of the existing housing loan. When you opt for refinancing, you can switch to another home loan with a shorter loan tenure or reduced interest rate.
Let’s consider the example used above, where you have an outstanding mortgage of $500,000 with Bank A at an interest rate of 2.5% and a remaining tenure of 20 years. Your monthly instalment would thus be $2,649.
If you choose to refinance with Bank B offering a lower interest rate of 1.8%, keeping the remaining tenure the same at 20 years, your monthly instalment would be $2,482.
You will enjoy a monthly saving of around $167. Over a loan tenure of 20 years, your total savings would then be $40,080.
Let us take a step back and compare the refinancing option vs paying down your mortgage loan as indicated earlier.
Refinancing your mortgage:
Upfront costs: $0 (Banks usually provide subsidies to cover your legal and valuation fees)
Total savings: $40,080
But there is a caveat: If your outstanding home loan amount is too small or the LTV limit is too high, banks may not consider your refinancing application, and even if they did, it may not be justified with the refinancing fees involved. Look for banks that provide subsidies to cover refinancing costs.
Prepaying your mortgage:
Upfront costs: $50,000 (your spare funds!)
Total net savings: $13,600 ($63,600 – $50,000)
There we have it. In most cases, prepaying your mortgage in Singapore should be your last resort. It suggests that you should only pay off your mortgage early if there are no suitable investment options that could yield you a higher interest than your current mortgage or if refinancing your mortgage will completely deprive you of savings.
Not sure about how to refinance? Find out the tips for housing loan refinancing.
Throughout 2022 and until now, rising mortgage rates have been a concern. The US Fed has aggressively increased federal funds rates to combat the inflationary concerns, without tipping into recession. Although inflation has been trending down, interest rates are expected to rise moderately in the second half of 2023.
Similarly, we have seen near-zero interest rates in times of crisis. The COVID-19 crisis is the most recent example. So, what does this all suggest? It means the current state of higher interest rates, like ups and downs in the past, will not remain the same.
A home loan is a long-term commitment stretching around 20 to 30 years. You can expect many uncertainties and fluctuations in home loan interest rates during such a long period.
It is important to take a holistic view of your financial situation before overcommitting to pay off your home loan early just because the interest rates are high now.
But remember that interest rates move up and down over time. Therefore, you should not worry about fluctuations in interest rates and focus on long-term affordability.
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