Choosing the right housing mortgage loan is a serious issue. In Singapore, there are two main types of mortgage loan available - bank loans, and HDB (Housing & Development Board) loans.
With the traditional bank loan, you’re faced with two kinds of interest rates: public interest rates (SIBOR or SOR) and internal board interest rates. You also need to put in 20% down payment on the property before being eligible for bank loans. Meanwhile, HDB loans have fixed interest rates and you only need to put in 10% down payment for the property instead.
Both bank loans and HDB loans allow you to use CPF-OA to pay them off. But an early repayment penalty applies for bank loans, with a lock-in period of 2 to 3 years. Bank loans usually apply a 1.5%-1.75% penalty for early repayment within the commitment period.
HDB loan interest is pegged to CPF OA (ordinary account) interest rate plus 0.1% per annum. Interest rate in the CPF OA is 2.5% p.a. (per annum), with an extra 1% p.a. for up to $20,000 available in the OA. Meanwhile, bank loan interest rates are reviewed monthly or quarterly, and lie between 1.4% p.a. to 2.6% p.a. currently.
Now that we have some background information, let’s find out how we can reduce the amount of time needed to pay off our housing loans.
Reducing Loan Period from the Start
Choosing the type of loan to take
Well, it’s better if you start from the top by choosing the type of loan to take, since loan type will determine the strategy you need to reduce the loan period. For example, if you can afford a 20% down payment and have the capacity to withstand volatile repayment amounts, a bank loan is the way to go. But remember that you also need to prepare 5% of the property price in cash.
This requirement isn’t present for HDB loans. That is why HDB loan is recommended for those who are risk-adverse or are seeking to pay off the loan later. Also, if your career is just getting started, a HDB loan is a more suitable option since the down payment sum required on your house is low.
Your loan repayment period matters
It’s tempting to choose a repayment long period for your housing loan. But remember that the longer the repayment period, the more interest you will paying. Before you choose how long a repayment period to take, perform cash flow analysis to see how much money you can set aside each month to pay off the loan.
As an example, if you apply for a $500,000 loan over 25 years at an interest rate of 2.6%, the total interest amount you’ll have to pay is $180,700. But if you borrow the same amount of money at the same interest rate for 15 years, the interest amount is only $104,440.
Putting money in investments versus putting money in repayment of loans
If investment returns are higher than the loan interest, you’re growing your money faster than the interest on your loan accumulates. That being said, fixed deposits are not suitable, since their returns are generally lower than the loan interest rates.
You can reduce the opportunity cost of your loan by paying it off with any profits your investments make. Also consider paying off your loan when you have spare cash and during periods when there are no suitable investment opportunities.
What Else can be done?
Refinance your home loans to reduce interest rates
Depending on the market climate, when you apply for housing mortgage loan, you can negotiate with banks to lower the interest rate. You can refinance with the same bank and negotiate to lower the payable interest rates, or transfer your loan to another bank if the rates after considering fees and charges are better.
If you apply for HDB loan, you can refinance it with bank loan. However, you can’t refinance the same bank loan with HDB loan later.
Pay more than your monthly scheduled payment whenever you can afford it
For a certain period, you’re required to do a monthly payment with the same amount of money. But if you really want to reduce the amount of time you need to pay off your housing mortgage loan, pay more than your monthly scheduled payment whenever you can afford it.
Received a bonus from work? Or having clinched a big deal out of regularity? You can set aside the money to pay your housing mortgage loans partially right away. The more you pay your monthly scheduled payment, the quicker you’ll be free from your loans.
Put money in investments with expected returns higher than loan interest rates
Wherever you put your money, do make sure that the expected returns are higher than the loan interest rates. If you consider yourself as risk-ready and have enough time and knowledge to manage investment, you can put your money in stocks and shares. The returns are usually 6% p.a.
But if you don’t have time to manage investments, you can put your money with fund managers, such as unit trusts. The returns after charges are still quite high in 4% p.a.
Meanwhile, if you’re using CPF to pay off the loan, this is when you should consider taking a portion out of an investment before the money is used for the property. This is because CPF offers a rather low investment return compared to your loan interest rates.
Let’s Take a Look at This Case Study
To give you a better understanding, let’s take a look at this case study. Jack and Jill each earn $4,000 per month. They took a $300,000 HDB loan for a period of 25 years at 2.6% p.a. interest rate and a monthly repayment amount of $1,361. They are keen to reduce the loan period to 12 years. How can they do it?
Jack and Jill can’t afford a higher loan repayment amount, but let us assume that their income and expenses are shared equally. After all expenses are accounted for, there is around a $200 surplus in their CPF-OA, and $200 in savings every month from each party.
Annually, Jack and Jill have a combined two months’ salary bonus, which totals to $16,000, of which $3,520 goes into their CPF-OA. Now we assume that they have $3,500 left in cash savings after spending their bonus on other necessities. The first $20,000 in each CPF-OA gives additional 1% p.a. interest, so they should only use the surplus of $20,000 to pay off the loan partially. It should take them five years to accumulate funds in their OA account to above $20,000.
Assuming they invest their monthly cash savings (total $400 a month) for a net return of 6% p.a., Jack and Jill can accumulate about $46,700 after five years. Meanwhile, they would have $22,300 each in their CPF-OA account. Jack and Jill can then use the excess of $20,000 in their CPF OA to invest, which gives them a net return of 3.5% p.a.
If this continues for five more years, Jack and Jill will each have accumulated $109,000 from cash savings and $48,800 in the ordinary account. Their total assets accumulated will be about $206,000. This will be sufficient to help them pay off the remaining housing loan and save about $42,000 in interest payments. Doing so will allow Jack and Jill to free themselves from debt sooner and direct excess funds into retirement planning.
Thus, with proper planning, it’s possible to reduce your mortgage loan period and set aside money for other purposes, such as children’s education and retirement. It pays to plan early too, as you’ll need time for the plans to execute!