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To Pay Or Not To Pay

>> Monday, June 6, 2011

Much discussion has been going on about paying off the housing mortgage or to take the maximum loan. Well, I would like to put forth my views.

Firstly, it depends if the loan is paid using CPF or cash. If using CPF, the constrains are obvious: (1) interest rate of 2.5%; (2) Cannot use the funds till 55/62; (3) Even if invested, there are bank charges and any current income derived goes back to being locked up. If using cash, it is a sacrifice of liquidity and possible opportunity cost.

Secondly, it depends if the loan is from HDB or the bank. If using HDB loan, the constrains are again known: (1) interest rate of 2.6%; (2) Inflexibility of loan terms; (3) Not allowed to refinance internally. If it is a bank loan, rates are generally floating, loan terms like tenor and amount can be varied.

So back to the question, to pay or not? Assumption of course is affordability is not an issue here, as this is out of the question if one cannot even pay off the loan to begin with.

For HDB loan using CPF, unless you are intending to invest your idle CPF funds and are confident of a rate of return higher than 2.6% compounded consistently, I would pay off the HDB loan.

For HDB loan using cash, switch to a bank loan.

For bank loan using CPF, I will take the maximum loan amount, but the shortest tenor. Bank fixed rates are lower than 2% at least for 3 years or some up to 5 years, since CPF cannot be withdrawn and earning 2.5%, it will maximize the returns. At the same time, if rates were to increase above 2.5% then pay off the entire loan, if not carry on to refinance after the fixed rate lock in is over at the new fixed rate lock in below 2.5%.

For bank loan using cash, this one is a little tricky. It all depends on the rate of return you feel you can achieve and how long you can carry on to achieve them. If the expected returns are consistent and above the floating rate, I will take maximum loan with maximum tenor. If rates float above my expected return, I'll pay down the loan or place in an interest offset plan and refinance in future when rates fall below my expected return.

Well, in conclusion, it all boils down to the expected rate of returns for the alternative use of the funds. If you are going to leave it in fixed deposits, then it would make more sense to pay the loan off or use an interest offset plan. Of course assuming due diligence of emergency funds, etc are already done.

Would love to hear alternative views or counter arguments. Thanks.

7 comments:

Temperament June 6, 2011 at 9:34 PM  

Hi,
I like companies, banks or CPF to pay me $interests$ rather than i pay them if i can help it. Any comment on this thinking? Is this logically sound?

Lau June 7, 2011 at 11:14 AM  

Well, it is a preference.

Maybe you are the type that will rent a place/room. So that you do not have to tie up any capital for your own residence or loan to pay any interest.

And invest all your capital in companies and banks for interest. At the same time leaving all your CPF for interest.

An operating lease rather than a financing lease. =)

Temperament June 7, 2011 at 8:34 PM  

I like your reply.Since you can think this way, I think they are people who are capable of doing it. Actually, i have not reach this classic stage of using capital. I think it's a very interesting way of employing capital but in Singapore there are no public housing for rental except very special cases for the "very poor".
"An operating lease rather than a financing lease." - "A Classic Thinking" Ha! Ha! i like.

Anonymous June 9, 2011 at 9:03 PM  

Actually, I wish I had a small loan. If you only need to pay off a small mortgage, then the "freed" capital can potentially be invested in income generating investments. The life insurance associated with a mortgage is one of the cheapest around, and should you unfortunately lose your life, your wealth bumps up immediately for your family.

Lau June 9, 2011 at 9:41 PM  

Temperament, always glad to learn more from open discussion.

Anonymous, you can actually do that by refinancing. However, it is only for private properties and not HDB. HDB, the work around would be to sell and buy with a new loan.

It is indeed how the rich are getting richer with leverage from the low loan rates.

Singapore Man Of Leisure June 21, 2011 at 6:36 PM  

Hello Lau,

Just chanced upon your post today and would like to share my own real life example:

http://singaporemanofleisure.blogspot.com/2011/06/i-would-like-to-follow-up-on-my.html

At the end of the day, it's up to the individual to pursue what's comfortable for themselves.

Lau June 24, 2011 at 3:43 PM  

SMOL, it is indeed up to ones preference.

Taking a blog/comment post from cw888 as well, apart from numbers, the psychological aspect cannot be expressed in dollars and cents.

Excuse the simplicity/details. But to quote the example:
A. 2 mil in investments, 1 mil in debt; or
B. 1 mil in investments & debt free.
Net worth mathematically is the same. But psychological security of burden cannot be computed. Leverage is a double edged sword.

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