Financial Freedom SG

In the last article, we looked at how to look at the most expensive flat you can afford on your combined salary. The rule of thumb for that to recap is around the 30% to 35% mark.

This part we will look at the part that most people will think through properly.

The number of years that you need for the housing loan.

For most people, including myself, the thought of paying off a loan as fast as possible is intuitive and prudent. This plus the thought of paying a staggering amount as interest payment. In the previous article we looked at, if we take a loan of $300,000, this will mean that a loan stretched to the maximum will mean that you have to pay more than one third of the total amount as interest payment.

So we should pay it off as soon as possible right?

The answer for many financial problems is, “It depends.”

Factors to consider when paying off housing loan earlier or to stretch it

The key issue to compare is the present housing loan interest rate versus the returns you can get in investment returns.

To put it simplistically, we can have these three scenarios:

1. Present housing loan interest rate < Rate of return for investment returns
2. Present housing loan interest rate = Rate of return for investment returns
3. Present housing loan interest rates > Rate of return for investment returns

If you are in scenario 2 and 3 and you are risk adverse, it is better to aim for paying off the housing loan as soon as you can.

If you are faced with scenario 1, and you have a diversified portfolio of investments, it is better to stretch the housing loan as soon as you can and aim to beat the housing loan interest rate of 2.6% for the HDB housing loan.

In case you like to look at the math behind this and learn about how the interest rates figures can be varied, you can look at an another article I have written on “Early House Payment or Invest the Sum?” In this article, I came to the conclusion that if you can get 5% investment returns or above, you should stretch the housing loan as long as possible and invest the sum you would have used to pay off the loan.

The other factors to consider for stretching the housing loan are:

• Liquidity of assets- If you have money all sunk into your flat to repay the mortgage, your money is illiquid and all stuck in the flat. But if it is in your investment portfolio, you have the added flexibility to sell it down to meet any unforeseen needs.
• Death of main or either of the breadwinners- If you have a HDB loan, it is compulsory to get the housing insurance which pays out the full outstanding housing loan upon the death of the breadwinner. Making it fully paid for by insurance money. Very bluntly, do you want your family to have a fully paid off flat but little to speak of in savings because you have been squirrelling away to pay the housing loan versus someone who has substantial savings Plus a fully paid off flat upon a sudden death?
• Inflation- While inflation works against you, for the housing loan, it helps actually. The $100 you have now, is worth less 20 and 30 years from now. So by not paying off early, you benefit from inflation.

To balance this, the other factors for paying off housing loan earlier are:

• No debt- a lot of people don’t like debt and think it is as dirty as your normal four letter word. Paying off debt makes you financial free, which is always good to have, especially if you have a fat bank account and investment portfolio to boot.
• Pay less interest- for me this was the key factor to consider paying off the loan as soon as possible, but I turned to paying off my housing loan by stretching it after considering all factors.
• Less risk- if you don’t have a $300,000 housing loan, it can be very liberating. You have a less fat bill to worry about on top of the electricity bill, the phone bill, the credit card bills etc.

In the next article next week, we will look at using the CPF OA to pay off your housing loan and some of the things you should consider financially when getting your first flat.

Source:

1. Don’t rush to pay off that mortgage

2. Should I pay off my home mortgage early or invest?

3. HDB Infoweb