Should You Pay Off Your Home Loan Faster?
I have encountered some home owners who are eager to pay off their home loan as soon as possible, be it for their private property or HDB flat. The conventional thinking is it’s prudent to be debt-free. The sooner they can clear their housing debts, the faster they can enjoy peace of mind or the more they can save on bank interests. These are valid reasons.
But sometimes things are not so straightforward. Take the current Covid-19 situation, for instance, would it have been better to pay off your home loan faster? If you have chosen a shorter loan tenure in order to clear your mortgage loan quicker, but it also means a higher mortgage loan payment each month. In the event of a pay-cut or loss of job, would you be facing a cashflow problem?
Paying off your home loan faster may be advantageous or disadvantageous, depending on the situation and your objectives. There is no one definitive answer.
There are at least three valid reasons for paying off home loan earlier.
Paying off Home Loan Early Helps Save on Bank Interest
One of the key reasons for quickly paying off the mortgage is to save on the bank interests.
Assuming that one takes a $1 million loan at 2 per cent interest, the monthly repayment amount and total interest paid will work out as follow based on different loan tenures:
It is apparent by reducing the loan tenure, the saving on interest can be very substantial. The only downside is the increasing burden of the higher monthly payment. By choosing a shorter loan tenure is akin to taking short term pain for long term gain.
To Be Debt-Free Is To Be Worry-Free
To be debt-free is to be worry-free. It gives you peace of mind without having the burden of having to set aside a portion of monthly income to pay for an outstanding loan. A housing loan usually is the most significant loan you would undertake in your lifetime.
Without any remaining loan also means you can plan better with your finances, such as retirement, investment, buying a luxury item or going on vacation. To be saddled with a big loan is to be worried about the inability to keep up with the payment, especially in a major crisis like the Covid-19 pandemic.
No Outstanding Home Loan Gives A Sense of Security
When a home loan is all paid up, it also gives a sense of security. To be debt-free gives one better control over his or her finances.
Should you face a sudden loss of employment, the last thing you want to be worried about is the possibility of defaulting on your housing loan and the risk of losing your home.
Fluctuating Interest Rate
While our current interest rate is at a historical low, it will not remain low forever. Our home loans are usually pegged to SIBOR (Singapore Interbank Offered Rates). Given the current Covid-19 pandemic, the 3-month SIBOR rate is now at an incredible low of 0.44%. Pre Covid-19 was about 1.87%. Just not too long ago, the mortgage interest rate was more than 2%.
Looking at the history of SIBOR, in 2006 (before the Global Financial Crisis), it was as high as 3.5%, which means a typical mortgage rate would be around 4.5% (compared to 1.3% now!).
In the last 27 years, the three-month SIBOR averages about 2.5%, that is, our average home loan is about 3.5%. This means that if you are taking a 25-year loan, you can almost be sure in the long run, you will be paying a higher interest rate than the current rate.
A 1% increase in the interest rate for a $1 million loan will make a difference of about $490 in monthly payment (for a 25-year loan tenure).
While the last ten years, we have been enjoying relatively low housing loan interest rates, should we enter into an interest-high environment, then it makes sense to clear the loan quickly.
If you are taking an HDB loan for your flat, the interest rate has been 2.6% for as long as I can remember. It is pegged to CPF 2.5% interest rate. The stability of the HDB loan rate may sound good, but it is currently considerably higher than private bank loans. One bank I know is offering five years at 1.4% fixed rate.
Disadvantages of Paying Off Home Loan Quickly
Singaporeans are quite fortunate. Our housing loan interest rates are about one of the lowest in the world.
This is quite different from many other countries, where interest rates can be much higher. As such, there may be greater urgency in rushing to pay off the home loan, given the higher rate.
While it’s always good to minimise interest repayments, our comparatively lower rate adds a new dimension to this. It may, for instance, be advantageous to maintain a healthy cash flow, or have cash to invest elsewhere besides our property, rather than giving full priority to home loan repayment.
That being said, here are some scenarios to consider, in deciding whether to repay your home loan faster:
- Are there prepayment penalties?
- What are your current savings?
- Do you own a private property or an HDB flat?
- Does hurrying the home loan repayment optimise your wealth accumulation?
Are There Prepayment Penalties?
For HDB loans, there are never any prepayment penalties, so you can feel free to prepay as much as you like.
For private bank loans, take note that there may be prepayment penalties for a certain period of time, such as in the first three to five years. If you try to make early repayments in this time, there will be a penalty imposed (the bank is trying to get back the interest they would have earned).
This penalty is often around 1.5 per cent of the amount you’re trying to prepay, and it’s almost never worth the cost; you should always wait till you can prepay without penalties.
Some home loans allow for partial prepayment, such as up to a $200,000 or some other sum, without any penalty. You should check the terms and conditions of the loan when signing up for it.
What Are Your Current Savings?
If paying your home loan early would leave you with little or no savings, then it’s a bad idea to go ahead with it.
Consider what would happen if you encounter some sort of financial emergency, such as job loss or a medical emergency. If you have no cash because you’ve been accelerating your loan repayments, what can you do in such a situation?
If you resort to using other loans, such as personal loans, then you’ve made a bad trade-off. Your home loan interest rate was below two per cent, or 2.6 per cent in the case of HDB loans. A personal loan is typically around six to nine per cent interest. You would have been better off keeping more savings, and paying the lower interest rate of your home loan.
If you own an investment property, by choosing a longer loan tenure, with a smaller monthly payment, you can enjoy a positive cash flow every month. Though you are paying interest, in essence, your tenant is helping you to pay.
Also, even if you finish paying off your home in full, it’s dangerous to go for long periods without savings. For example, imagine if you rush repayment, and pay off your flat at the age of 45, while having little savings. What happens if you’re unexpectedly retrenched afterward?
Having a fully paid-up flat, in such a situation, won’t pay your utility bills or buy you food (unless you’re happy to sell it, which might ruin the joy of having paid it off in the first place).
So if you do want to accelerate your home loan repayment, please ensure that you have sufficient savings first. In general, you should at least have enough to maintain yourself for six months even without income.
Once you have a comfortable level of savings, you can then commit to paying more into your monthly home loan, or paying it off altogether.
Do You Own a Private Property or an HDB Flat?
Private property provides advantages that HDB flats don’t have. One of these is the option to use cash-out refinancing, also known as home equity loan.
Cash-out refinancing allows you to borrow up to 75 per cent of your property value, less your outstanding loan and CPF used. The interest rate is the same as a home loan rate, as your property is the collateral for the loan.
This means that, if you accelerate home loan repayment but find you need cash later, you still have an option: you can use cash-out refinancing to unlock your equity value and get cash without the need to sell your home.
As such, private property owners can face lower liquidity risks in paying off their home loan faster.
For HDB flats, you do need to tread more carefully because you can’t unlock the equity value of a flat like a private condo.
Does Hurrying The Home Loan Repayment Optimise Your Wealth Accumulation?
The main benefit of speeding up home loan repayment is to pay less interest. However, you should have a concrete plan to weigh up your options.
For example, what do you intend to do with the money once your property is fully paid up? Do you have other investment options?
Instead of putting all your money into your loan, how about investing them to get a higher return? If you could invest your cash and grow it at five per cent, for instance, it may be better to use it for that purpose, rather than to speed up repayment of a home loan with an interest rate of just around two per cent.
Or if you are taking a loan at 2% interest to purchase an investment property which gives you 3 to 4 per cent rental yield, you still make a net gain. Using up all your cash to pay off your existing loan may mean insufficient cash reserves for your investment property.
Accelerating your home loan repayment can mean opportunity costs, reduced liquidity, and doesn’t always optimise your wealth accumulation. There are times when it can be beneficial, but you need to have a clear plan ahead of you.
If you’re uncertain whether it’s right to accelerate your home loan repayment, do drop me a message and I can help to provide some clarity. I’m also available for any of your questions on building wealth through property.
Danny Han has been a licensed real estate agent since 2005. He also had five years of experience as a financial consultant. The insights and knowledge he shares in his blogs are the results of years of experience in helping many of his clients in their Property Wealth Planning.
Prior to becoming a real estate agent, Danny was a full-time church pastor (don’t be shocked!) for 23 years. Even now, he is still actively involved in church work and preaches regularly. He has also made six mission trips to Myanmar to-date.
Danny is a foodie, so during his spare time he would go with his kakis to try different “CNG” (cheap and good) food. (Be sure to check out his Holland food blog in this site).
Do feel free to drop him a Whatsapp message for a non-obligatory discussion if you are planning to grow your property wealth.