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Take your time to pay down your HDB housing loan.

Monday, April 7, 2014

In the guest blog by Klein recently, he offered his reasons why we should not repay our HDB housing loans too quickly. One of the reasons is that we would be losing more in interest income from the CPF-OA than we would be saving by avoiding the 2.6% HDB home loan interest rate.

Now, this is unconventional thinking, at least to me, which seems to make sense. This was another reason for me to share it here in ASSI with everyone. Of course, it does not mean that I think it is the way to do things but it does offer an alternative which is worth considering.

In my reply to a reader on this matter, I have offered some numbers which could make things a bit clearer, I hope.

Let us assume that a person had an outstanding HDB home loan of $100,000 which was meant to be repaid over a 10 year period and let us assume that he chose to pay down this $100,000 in loan using money in his CPF-OA in one lump sum. How much would he be saving in interest payment?


Using an amortising calculator, $13,670. This would have been the total interest payment of the loan over the 10 year repayment period.

Now, if this person had not repaid the $100,000 loan in a lump sum but instead chose to leave the money in his CPF-OA to earn 2.5% in interest income per year, how much would he be able to accumulate over a 10 year period? Compounding 2.5% a year, $28,008.

Of course, I am assuming that this person stays in active employment over the 10 year period and that his monthly CPF-OA contribution is able to cover the monthly repayment of $947.25 to HDB.

Naturally, this person would not be receiving any interest income for this $947.25 that is paid monthly to HDB but he would still benefit from interest earned by that $100,000 in his CPF-OA that is left untouched. Isn't this a better arrangement than not having that $100,000 in his CPF-OA and having to start accumulating funds again in his CPF-OA at the rate of $947.25 a month?

This perspective offered by Klein, if I have understood it correctly, is an interesting one for me as I have never bought a HDB flat before and have never been faced with a choice like this.

When I bought a private property some years ago, I had to pay an interest rate of 5.1% on my home loan while money in my CPF-OA was earning only 2.5% and money in my savings account was earning 0.125% per annum in interest income. In my situation, it made sense to pay down the housing loan as soon as possible, of course.

So, does it make sense for you to take your time to pay down your HDB housing loan?

(Please read the comments that follow this blog to gain a better understanding of the issues involved here. In particular, please read comments by PSTan, kael1n and SnOOpy168.)

Related post:
Tea with Klein: HDB Housing Loans.

45 comments:

AK71 said...

This exchange just took place by PM on FB:

M:
Haha ak thanks for the hdb post But if we buy hdb n get a loan We need to clear our oa acc before we can get a loan
So i don think we can keep the 100 k n apply the compounding on it

AK:
What about the possibility of having that 100K or some surplus amount after a 20 year period? so, there is a 10 year period left to the loan in such an instance.

M:
Hmmm .. means pay lesser so that we can accumulate more.. Ok i got u

好人 said...

I agree with M. We must consider our monthly contribution n repayment every month. Hardly anyone would be able to contribute much to OA after deducting for hdb loan. An alternative in this low interest environment (where banks offers a lower interest rate) is to pay off the loan in the shortest time and start accumulating money in the OA thereafter.

yanhan said...

By paying down early, the loan which we no longer have to pay will generate interest in OA as well, wouldn't it?

PSTan said...

It seems to me that the perceived saving might not be accurate, as the new contribution rightfully earn interest in CPF-OA too, if the 100K will to pay upfront.

PSTan said...

Base on my calculation, the correct cost for serving the loan monthly compared to leaving the 100k in the CPF-OA is $13,670 + $15,835 (Interest that should had been earn over the 10 years from the monthly contribution of $947.25, if the 100k had been paid down upfront), with a total of $29,505.

This is

Grace Keren said...

actually it is possible to "keep" aside the CPF money before you apply for the HDB loan. Transfer the funds to CPF investment acct for the time being ......

SGYI said...

Hi AK,

There are people who loan from banks at an interest of 1.5% only. I've heard people strategising that as long as their loan interest is lower than the cpf oa interesr, then they will slowly pay the loan. Unless the loan interest goes up higher than the cpf oa interest then pay down more.

AK71 said...

Hi 好人,

Each person's circumstances and, therefore, CPF contributions will be different. You are right.

Also, we are all made differently and while some are comfortable with debt, some would prefer to pay down debt as soon as possible, good or bad debt doesn't matter. I am like that too. :)

AK71 said...

Hi yanhan,

Yes, if we had used $100,000 to pay off the debt in a lump sum, we would earn interest income on our monthly contributions to our CPF-OA account too but we would be starting from a very small base (i.e. small sum of money) and the compounding effect is much smaller in the beginning. It is like starting from scratch.

AK71 said...

Hi PSTan,

If your calculation is correct, then, it would support the case for an early lump sum repayment. Unfortunately, math was never my strongest subject in school. :(

However, I would have thought that the opportunity cost that comes with the monthly repayment of $947.25 is lower than the opportunity cost of a $100,000 lump sum payment.

AK71 said...

Hi Grace,

And I know people who actually did that. Brilliant. Of course, I hope they did not lose any money in the process.

AK71 said...

Hi SGYI,

Yes, that is a more straightforward way and that was what my blog post on the POSB HDB Home Loan was about. POSB HDB Loan: Peace of mind.

With this, try to repay the loan completely in the 10th year (correct at the time of blogging; I was told that the time period has been shortened to 8 years now).

SnOOpy168 said...

Hmm... perhaps I am the rare few who did early repay my HDB loan.

Got my resale flat's key in mid 2006. The loan payment was manageable that should I loose my job, standing behind McD will still help to repay this.

While i looked back and see that I should have invested those cash, generate load of passive income which will pay off the monthly repayment and when it is done, this passive income will continue to feed me until those investment are no-more / liquidated / closed down / i m 6ft under. Whereas now, that 6 fig cash has gone to HDB.

<>

1. As a single, that 6 fig loan is scary. Hence, the objective is to get rid of it ASAP. Partial prepayment of capital was installed to me by a classmate who paid of their EC early, saving generously on interest. Most of us thinks he the seow one, should invest that $$ etc etc. (a.k.a convention thinking)

2. The dual "interest" payment. I had to pay HDB 2.6% for that loan, which is repaid from CPF OA. The amount taken out from OA, I had to reimburse the 2.5% interest that the fund would have earned, should it be untouched. Yes, that is still my $$$ at the end of the day, should I sell later. This means that the nett profit which I can take out , will be lesser.

3. Those 2 interest are compounded. I recalled trying to redeem the OA amount paid, 3.5 years later, after I repaid that HDB loan. CPF allows this but on a lump sum & cash only basis. Meaning that it's either all (amount taken out plus interest) or nothing. The officer and I were on the phone a few time, trying to calculate the exact amount.... That cleared.

4. When I repaid the loan, another good news pop up. I can apply to legally rent out my HDB. No grant and no outstanding loan requirement was 3 years occupancy. So, the HDB becomes my cash cow. ^-^

Upto here, I can tell you that feeling of walking out of HDB & CPF office knowing that you have cleared all these obligations. Hmmmm, remember handing in your final year's final papers ? That kind of wonderful and lost feeling.

My bro told me that next month, suddenly you bank & OA account is very positive. True. I did call up to ask WHY NO DEDUCTIONS ! Their reply, "Sir, you had full paid up your loan. There is nothing to deduct".

Yup, gone out to celebrate by restarting my old hobby on photography.....

at about that time, I discovered this blog called ASSI & the character called AK71..... and was introduced to the world of passive income.... Cheers AK

AK71 said...

Hi SnOOpy168,

Thanks for sharing your experience with us here. There is nothing like a real life story to throw light on an issue.

You have pointed out the good and the bad of early repayment of your HDB housing loan. A nice balance which I am sure readers will appreciate. :)

I guess, at the end of the day, it is what gives us comfort and a peace of mind. Some of us are more comfortable and better with debt than others.

Money and happiness, if I had to choose one, it has to be the latter. ;)

kael1n said...

This post is misleading.

PSTan is on the right track.

All else equal, lumpsum payment of the loan is economically better than paying monthly.

This is because the cost (2.6%) is higher than the interest income (2.5%).

Obviously, if you can borrow below 2.5%, then the opposite is true

AK71 said...

Hi kael1n,

Oh, dear. I have no intention of leading anyone anywhere with this blog post at all. I apologise if you think it is misleading. :(

I was just elaborating on a idea which has been shared with me by a reader (and I hope I understood him correctly) and I was just wondering if it could make sense. That is also why I ended the blog post with a question to invite readers to share their perspectives. :)

AK71 said...

Hi kael1n,

I thought about it a bit more.

If the effective cost of paying $947.25 monthly amounts to $29,505 over a 10 year period, it would mean $1,505 more in cost compared to a lump sum payment of $100,000.

So, it would make sense for anyone who might want to save on this extra cost to make a lump sum payment.

If we are able to improve our returns by doing something else with our money in the OA, then, we have to weigh the opportunity cost of an early repayment.

Thanks for weighing in on this. :)

Pips said...

If the money in CPF is substantial enough, wouldn't it be ideal to invest in in reits fund and using the dividend payout out to cover the house loan monthly since reits typically generate abt 5% or even more...

Steven Yap said...

Hi AK,

Imo, this HDB loan repayment thing has many solutions to it. Each depends what is the situation each owner is facing.

Some like to keep more CPF money at hand as a crisis fund in the event they are not able to pay off the monthly installments because of some crisis in life. When you have a CPF crisis fund, at least you know when you are in trouble, you can fall back to it to help pay the installments for at least a year or 2. You can at least know, you dont need to fork out cash.

Some like to "1 shot" clear off the housing loans, because they want to avoid the interest payments. That is always perfectly fine if you are financially capable of doing it. These people usually i think, have a bigger pool of CPF resource to draw upon, thus able to clear off the loan in one go.

Whatever methods you employ, you can always use the excess CPF funds to invest in low risk funds or stocks. Usually the returns are better then the interest from government, imo. As long as you are not greedy, i guess... lol

I think there is no best way to do this, only the most suitable way for you.


Best Regards,
Steven

Nickguthe said...

Also not to forget first $20k of OA earns extra 1%, making it 3.5%.

SnOOpy168 said...

I must add that no thanks to that invisible fund called cpf, everyone seems to have the mind set that "let cpf pay lah. It's my $ anyway". Also, that "it only cost 2.6%, when that funds can be rolled for 7-10% (or whatever) % returns. Why pay cash, when the funds are in CPF that you are unlikely to see the lump sum cash.....

Sure, assuming that returns can consistently generates such high returns. Yearly until that loan matures. Than it will be Mr. Market pays for your house. Liked that idea too.

Someone did tell me that had I invested that spare cash in the stock market, instead of paying off the HDB loan. I could have lost my shirt. Why ? 2005-2009, what happened to stock market ? Boom & bust, if you know when to get in low and get out high. Seriously, that $$$$ is yours to keep. Seriously, how much "school fees" one had paid over the years of investing ? For sure, until now, I still dunno when to get out or cut loss. But had the entry price & returns be as good as when I started investing, then that lump sum invested could have feed my lust for oyster lobster & wine buffet, daily.

Right now, my gf has a flat that she is paying via CPF. All spare cash & savings are used to generate passive income. to make things simple for her understanding, I just told her that since this year the SP bills are paid for by Mr. Market. Next target will be to include the Town Council charges to Mr. Market's payment. The ultimate goal is that Mr. Market can pay for the flat's installment & running cost.

Should I reinvest those gains ? Yes, at the right entry price of my preferred counter.

Oh, why not prepay that loan's capital. It is commercial bank loan with lock in period and some other penalty. I will review that when the time comes.

AK71 said...

Hi Pips,

Well, it might look attractive to do that but the level of risk involved is quite a bit higher. Of course, if we managed to get in with a fairly good margin of safety, then, it is less of an issue. Then, we could possibly get a free apartment from Mr. Market and this is what I want too! :)

AK71 said...

Hi Steven,

Indeed so. I told Klein the same thing in my reply that we will have to throw in a psychological bend to it all. What gives us a peace of mind?

Of course, before we do anything, it is only prudent to consider all the things that could possibly be wrong or go wrong. We sometimes overlook certain details which is why a discussion like what we are having now is so useful. :)

AK71 said...

Hi Nick,

That crossed my mind but it makes the calculations a bit more complicated. So, I did not take that into consideration when I calculated how much $100,000, if left in the CPF-OA, could generate in interest income over a 10 year period.

AK71 said...

Hi SnOOpy168,

We could use the CPF-OA funds to generate higher returns from the stock market but people who do this must remember that it is also riskier to do so. Mr. Market provides no certainty while the CPF does. You have elaborated on this so well. :)

Your girlfriend is lucky to have you as a military adviser. ;)

youngnewbie said...

Hi AK71 and peers,

Understand that the conclusion that most people had is to repay hdb loan asap.

I had a different point of view. The rate provided by hdb is 2.6% which is much lower than the personal loan and car loan that banks provided. The rate offer by banks range from 5-7%. The lump sum payment can be used to pay of car or personal debts.

In additional, I was told that if someone intend to get 2nd house and collect rental from it. The debt from the first house can be used to lower the tax on the rental income from the second home.

Lastly, the npv of a monthly payment from far future is lower than the monthly payment from a nearer date. Nevertheless, the lump sum can used for investment that offers good deals, low risk and higher returns compared to similar products.

However, if one does not have intention to invest or etc, it will best to pay off the housing debt asap.

Conclusion, it really depends on individual situation, personal wealth management and risk appetite.

Cheers people.

Newbie who is still learning.

AK71 said...

Hi youngnewbie,

This is a common line of reasoning I use on some people I know as well. If the most sophisticated investment we are comfortable with is a fixed deposit, then, we might be better off paying down all our loans instead.

I like the angle you have provided on the NPV of money. This is something I always forget. ;p

I don't understand this though: "In addition, I was told that if someone intend to get 2nd house and collect rental from it. The debt from the first house can be used to lower the tax on the rental income from the second home."

Could you clarify?

PSTan said...

Hi AK,

Obviously, if we know how to invest using CPF-OA amount without losing it, keeping it in CPF-OA is definitely a better idea than paying the HDB loan with 2.6% interest rate in lump sum.

However, for those who do not know how to make good use of the CPF-OA amount successfully, it is better off to just pay off the loan.

AK71 said...

Hi PSTan,

Thanks for the nudge. Plugged a hole in the blog post. Appreciate that. :)

BP said...

Can send me the armotising calculator?

AK71 said...

Hi BP,

There are quite a few free to use calculators online. I used this one:

http://www.calculatorweb.com/calculators/amortcalc.shtml

kael1n said...

AK, I agree with all your comments which was why I caveat my statement by saying "all else equal" and basically just comparing the 2.5% and 2.6% in a vacuum. =)

In a vacuum does not really exist in the real world, for someone that can use the funds and earn a return well in excess of 2.6% (yourself as a good example), the comparison is no longer straight-forward

AK71 said...

Hi kael1n,

I am a poor candidate for an example since I have never been in a situation like this before. ;p

Actually, I have a substantial sum of money in my CPF-OA which I am just leaving to fallow. I am not doing anything with it apart from using it to contribute $10 a month to a housing loan.

My CPF-OA, for a while now, is one of my 4 war chests to be utilised in case Mr. Market goes into a really bad depression. In the meantime, the funds earn a risk free rate of 2.5%. Can do lah. :)

M SI said...

Hi AK,

For Non-savvy :

A lump sum prepayment has a better facade as compared to taking up any loan(s) - Be it HBD 2.6% Fixed or Bank Competitive SIBOR/SOR Rates

A clear-cut reason is there isn't any interest payments. The definition of interests is to pay more than initial sum.

Again, in a catastrophic or phenomenal event, it is good to be debt-free else less one burden. During bad times, less this burden, may be a blessing to you should you chose to lump sum.

For Savvy Ones:

Should you have absolute confidence in gaining better returns from the initial capital, kindly proceed with caution.

It would be good to have at least a safety net to mitigate against unforeseen circumstance.

But, wouldn't it be good to get rid of a debt-stupid (excuse me) burden since you have the financial competence.

Sacrifice Small Me, Gain Bigger Me!

2 Cents Opinions,
Ken

AK71 said...

Hi Ken,

Thanks for this.

Yup, everyone's circumstances and considerations are different. So, each person will have to choose a path most suitable for himself or herself. :)

yeh said...

Hi . This is a very good discussion topic.
I also wonder should I use my cash+cpf to clear the hdb loan.
Currently I am still serving 280k bank loan with 1.5% interest.
I have enough cash to pay off the debt.
A friend ask me to settle ASAP.
Another one ask me to wait for property crash to buy one more property or use it invest in shares.

Hubby also doesn want settle the HDB loan.

Now. I also dunno what should do.

AK71 said...

Hi yeh,

Yours is what some would call a good problem to have. LOL. ;p

Well, if my property loan has an interest rate of 1.5%, I wouldn't want to pay it down in a hurry with my CPF-OA money which is getting 2.5% in interest income.

I would keep my CPF-OA as a war chest to seize investment opportunities if they should present themselves. :)

PSTan said...

If the loan cost is only 1.5%, probably there is no hurry to pay off the debt. This is especially so, if we know how to invest prudently to earn a better return.

Ultimately, CPF-OA is earning interest of 2.5% which is higher than the cost incurred. Even for cash, the Time Deposit could earn you 1+% interest.

yeh said...

Hi AK.
I have cash + ntuc fund about 190k. Wonder should keep it as emergency fund
Or use it to clear the debt.

This is the money. Hubby said Cant touch!
Since cant touch for investment.
Maybe just wondering use to clear debt also good!

AK71 said...

Hi yeh,

Yikes! Sounds like a domestic affair is creeping into the picture here. haha... You have to ask your hubby for a clear definition of "can't touch". If he means "break glass in case of emergency", then you better don't touch. We need a meaningful emergency fund. Of course, whether $190K is too much is for you and him to determine. :)

xin said...

Thanks for this post and all the comments! I'm also pulling my hair out for this topic. and i'm a newbie investor, so not hitting that 10% on investment gains.. but i think gaining more than mortgage loan interest is possible. thinking to take 30 years loan, and pay it slowly, month by month. agree than opportunity cost of lump sum payment is high. would prefer to keep as cash to invest in market downturn :)

AK71 said...

Hi xin,

Sounds like you have a plan to grow your money. Good on you. :)

Solace said...

I was reminded to the fact there is accrued interest charge when we sold a HDB flat using CPF money.

"If you sell your HDB flat, you need to refund the principal amount you had earlier withdrawn for the purchase of the flat, including the accrued interest, to your CPF account. This interest is the amount you would have earned, had the savings not been taken out"

Source: http://mycpf.cpf.gov.sg/CPF/my-cpf/buy-house/BH7.htm

perhaps this will be a stronger reason to pay back HDB loans asap for normal people.

Ak, you can highlight it to your readers, in case they are not aware.

it slipped my mind the other time.

den said...

Hi AK,

Would like to hear your view.

I am currently late 40 yrs, and is servicing a hdb bank loan about 250k with 3 yrs fixed rate about 1.6 - 1.7%.

My OA now is about 160k and SA about 90k.

In your view, is it worthwhile to pay down a partial amount (say 20k) from OA in order to reduce the 250k loan ? or leave it as it is ?

Another question about minimum sum at 55 yrs, after setting aside for minimum sum, the excess amount can use to service bank loan ? Thanks.

AK71 said...

Hi Den,

Money in your CPF-OA is currently paid 2.5% to 3.5% in interest. There is no reason to pay down your home loan which cost only 1.6% to 1.7% in interest with your OA's money.

However, if the interest on your home loan should one day rise to be higher than 2.5%, you could consider using money in your OA to pay down the loan.

At Age 55, if you have enough funds in your SA and OA to meet the Minimum Sum required, the rest of the money is yours to do as you like. You could withdraw them too. So, you can use them to repay your home loan.

You might want to see the video on Turning 55 by the CPF Board:
Video on reaching 55.

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