It’s a miracle! For years you have leaned over your home loan, thinking you’re never going to pay it off. There you go, long before you even turn 55, you check out the mortgage and realize: hey, you can pay off the outstanding home loan right now if you want to.
And the faster you pay off the loan, the less interest you pay, right? But make a few phone calls and you’ll likely come across at least one mortgage broker wiggling their finger and telling you to reconsider your decision. It turns out that the issue of prepaying your mortgage is more complicated than it seems.
This is one of those situations where sometimes it may even be less financially prudent to prepay the unpaid loan. Here’s what to consider before moving forward:
Why isn’t it always better to prepay the mortgage?
- Locking in money on your property is dangerous if you run out of savings
- Considering the low interest rate, you might be better off investing the money elsewhere
- You have higher interest debt that you need to pay off first
- Your mortgage can be insured anyway
- The early repurchase of your mortgage is not always free
1. Locking in money on your property is dangerous if you run out of savings
Here is a typical scenario where a prepayment could be dangerous:
Suppose you owe $ 300,000 on your home loan for your apartment, and you don’t have much else in the way of money. As a windfall, you end up getting $ 300,000 in inheritance, winning the lottery, etc.
You decide to use the $ 300,000 to pay off the lump sum loan because it means that there is no more interest repayment.
Great, but now what happens in an emergency like a layoff or high medical bills?
You cannot “reverse” the payment you have already made for your apartment. At the same time, you cannot pay your medical bills or everyday expenses with your apartment; bill collectors don’t care if you don’t have an outstanding home loan.
This can lead to unwanted alternatives, such as downgrading the apartment, renting rooms, or using other forms of credit.
And once you resorted to methods like personal loans, you would have made the wrong decision: your HDB loan interest rate would only be 2.6% per annum, and a home loan of a private bank is currently around 1.3%. Both are cheaper than unsecured bank loans, which range from six to nine percent per year.
As such, it is generally not a good idea to rush a mortgage repayment unless you still have enough savings afterwards *.
* This is often defined as six months of spending, but consult a qualified professional regarding your personal finances.
Private owners, however, have an option that HDB owners do not have in these situations.
Let’s say you rushed to pay for private property, instead of your apartment. If you run out of money afterwards, you have an option that HDB owners don’t.
You may be able to get cash-out refinancing: this is a bank loan that uses your home as collateral. You might be able to borrow up to 80% of the value of your home (subject to bank approval), at fairly low interest rates – often as low as $ 1.30. 1.6% per year.
However, that means you’re back to square one as you have a big home loan to pay again (otherwise the bank will foreclose). Moreover, there is no guarantee that a bank will grant you such a loan, as you still have to adhere to parameters like age limits, total debt service ratio (TDSR), creditworthiness, etc.
Either way, even if you have private property, avoid rushing your mortgage repayment if it leaves you too strapped for cash.
2. Considering the low interest rate, you might be better off investing the money elsewhere.
At present, the mortgage rates in Singapore are only 1.3%. This is expected to persist until 2022, given the US commitment to keep interest rates low.
Financially savvy homeowners, such as those who know how to negotiate and invest, should take this into account before paying off their entire loan. Consider, for example, if you have an outstanding balance of $ 300,000, with an interest rate of only 1.3%.
Rather than locking in the $ 300,000 in your property, could you invest it in a way that beats the 1.3% mortgage interest rate?
We will not recommend any investment product here as we are not financial advisers; but we are convinced that there are a multitude of better ways to use money that most financial professionals can offer you.
Even without active investment, some homeowners may find that they can beat the home loan just by letting their CPF build up (2.5% in the regular account and 4% in the special account). So why would they rush the repayment and lose cash?
3. You have higher interest debt that you need to pay off first
If you have money on the side, always prioritize other debt over your home loan (for example, credit card loans add up to around 26% per year).
You should never pay off the home loan first because it is the debt with the lowest interest rate.
4. Your mortgage can be insured anyway
One of the concerns of homeowners is that if they die their family will be grappling with the outstanding home loan. As such, they want to repay the mortgage as quickly as possible.
But HDB owners already pay for compulsory mortgage insurance, in the form of the Home Protection Scheme (HPS). The HPS will reimburse your current mortgage if you die or suffer from total permanent disability.
Homeowners can purchase Mortgage Reduction Term Insurance (MRTA), which if you haven’t, you should do it right away. The MRTA will also reimburse your current mortgage in the event of death or permanent disability.
You don’t have to rush your mortgage repayment for fear of it, just insure your mortgage.
5. The prepayment of your mortgage is not always free
Read the terms of your home loan carefully. Some loans impose a prepayment penalty – often within the first three to five years – if you try to prepay the loan. This is usually 1.5% of the outstanding loan amount.
It is usually a waste of money; you’d better wait until the end of the period before paying off the rest of your loan.
However, this is not a problem with HDB loans, which never come with prepayment penalties.
When is it best to repay your mortgage early?
- You want to buy another property
- Interest rates are high
- Credit reasons
1. You want to buy another property
Your current home loans affect the maximum loan amount you can get on subsequent home purchases.
|Number of mortgage loans outstanding||Maximum funding possible||Minimum deposit that must be made in cash|
|0||75 percent||5 percent|
|1||45 percent||25 percent|
|2+||35 percent||25 percent|
Note that the financing may be further lowered, in the event of a bad credit rating, exceeding age limits or loan terms, etc.
The down payment may be too large to be viable if you don’t pay off your existing home loan first.
2. Interest rates are high
Singapore mortgage interest rates were once much higher; about 3.7 to 4% was a norm.
It is just a series of unusual events – from the global financial crisis in 2008 to the Covid-19 situation today – that have kept interest rates at 2% or less for more than a decade. .
One day, however, will come the time when interest rates will rise again. It may be many years away; but when it does, it will be time to consider whether prepayment is better given the higher interest rates.
3. Credit reasons
This can be important for non-real estate reasons, such as if you are a business owner and need to get working capital loans. Paying off your home loan can improve your creditworthiness because it is one of the most important long-term debts.
As you can see, this is not a clear “good or bad” answer.
This decision really depends on the state of your personal finances and your short or medium term goals (eg you want to buy another property). However, this is not as clear as “prepayment = always good”.
If you follow personal finance websites in other countries, keep in mind that their home loan market may be very different from Singapore. In many other countries, for example, home loans tend to have a much higher interest rate than ours, and can involve much smaller amounts.
Contact us if you are unsure and we can ask an expert to review your situation. In the meantime, you can find the latest real estate investment news, updates and strategies on Stacked.
This article first appeared in Stacked houses.