Tuesday, 13 January 2015

Housing Mortgage Loan


Last weekend, we reduced our mortgage loan period to 13 years. In fact, we can reduce it to 10 years based on our current income but we choose to have a little buffer. We will make lump sum repayment whenever our CPF OA exceeded $20,000. Pleaste note that the first $60,000 in your CPF accounts earn 1% interest more, of which $20,000 can be from CPF OA.

You will be surprised to know that the major factor in paying much higher interest is the length of your loan. Interest rate and loan amount is also important, but the effect of compounding interest over time is even greater. For example, a loan of $230,000 :

Loan Repayment Period
10 Years
30 Years



Total Interest ($)
$ 31,442
$ 101,482



Total Payment ($)
(Loan Amount + Total Interest)
$ 261,442
$ 331,482



% of Total Payment Spent on Interest
12 %
31 %

As you can see, the interest paid for the same amount for 20 years difference is more than $70,000!

Of course, there are other factors such as :

1) CPF accrual interest you owed to your cpf account shall you sold your flat
2) 2.5% interest that you can earn if the money is untouched at CPF account

This is never a straight forward calculation as mortgage loan use monthly reduced interest payment while CPF use typical annual compounded interest. 

I am not a fan of debt, I would prefer to fully pay off my mortgage loan by 40. This is aligned to my financial goal to be financially independence by 40 too. Any money accumulated in CPF OA after 40 will be my retirement fund.

I have made my move, how about you?

Towards Debt-Free Status
Frugal Daddy

7 comments:

  1. Hi FD,

    I used to have the same thinking as you but not anymore.

    Let's assume your mortgage is 100k and you have 100k sitting in ur OA.

    Would you use it to clear your mortgage loan or just keep it as your warchest?

    Cost of mortgage is actually 0.1% since loan is 2.6% and CPF OA rate is 2.5%. So what's that? $100.

    Also I believe you have HDB mortgage insurance. So if anything happen, your insurance will keep in.

    Regards.

    ReplyDelete
    Replies
    1. Hi Whowillbe,

      Thanks for your sharing. I agreed with your points.

      However, mortgage loan use your entire loan amount to derive the interest payable and reduce with your monthly repayment. Whereas cpf pay you interest by the month you have in cpf. It is not 2.6%-2.5%, simply. With the accrual interest, the math is even harder. It will be very significant if you are paying by cash for your mortgage loan. Since I am aiming to achieve FI by 40, I would take the marginal savings and be debt free. I will only invest with money I can afford to lose. Peace of mind is priceless. In addition, I may sell my flat as it resides at a prime area, so it does make more sense for me to save more interest as mortgage loan interest is heavy for the first few years. I may redeem my mortgage loan in much earlier because of that. Then, we can invest cpf oa in either property or stock and property will not be subjected to limit of loan as you are no longer servicing any existing loan. Both way works, depends on individual priority. However, my post is to share the compounded interest incurred if your loan period is longer. I will do an update and enhance post in near future :)

      Do give more feedback! Thanks

      Delete
  2. Hi,

    My example was one where the OA available for downpayment = mortgage outstanding.

    The reason why I such an example is that if one is in such a situation, he most probably would not pay off his loan but instead keep the OA and use it to get bigger returns than the 2.6%. Even if don't invest, the cost is only 0.1%.

    Now I understand most are not in that situation. But imagine if one speeds up the repayment by 1k every month, he's only saving 0.1% of that 1k every month. But that 1k that he chose to keep in his OA might come in useful.

    But again I do respect that everyone has different risk tolerance and feelings towards debts.

    ReplyDelete
    Replies
    1. I fully agreed. However, only 15% of cpf oa beats cpf interest. I am actually 1 of the 15%. :) I would think cpf oa is a AAA Bond. Using it as warchest during market correction is a smart move. I may reconsider my stance after I do my math further :) thanks.

      Delete
    2. I fully agreed. However, only 15% of cpf oa beats cpf interest. I am actually 1 of the 15%. :) I would think cpf oa is a AAA Bond. Using it as warchest during market correction is a smart move. I may reconsider my stance after I do my math further :) thanks.

      Delete
  3. I think it all boils down to this: if you can pay as much as you can today, then do it. Do not prolong the mortgage loan period, and thus leave more worries for the future. Interests can accumulate, and the more years you give for it to do so, the bigger is your problem. Thanks a lot for putting this in a clear and concise manner. Good day!

    Naomi Cruz @ 4 Pillars

    ReplyDelete
    Replies
    1. HI Naomi Cruz

      Greeting! When US interest rate rise, the mortgage interest rate will rise too. It will be wiser for private mortgage loan owners to repay as early as possible. Mortgage loan is certain while investment returns are not. Good day!

      Delete