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(This article is contributed by ValueChampion Singapore, a personal finance research firm)
If you’re a homeowner with a mortgage and extra cash on hand, you’re likely struggling with a dilemma: Should you pay off your mortgage, refinance, or put the money to work in investments to build a nest egg? We compare the choices against each other to find out which nets a greater return below.
Key insights:
Assuming an initial home loan of S$200,000, investing the amount into an STI ETF like the Nikko AM can produce returns nearly 10 times as much as the total interest paid on a HDB loan.
Paying off mortgage early - then running in cash flow issues - can cause you to pay more than S$20,000 worth of installments when you resort to taking out a personal loan.
paying off your mortgage early saves you on interest payments (more than 50% if you pay off a S$300,000 loan in 5 years, compared to 10 years).
Singapore’s housing market is among the most expensive worldwide. For reference: HDB properties cost an average of S$532,768. Compare that to the average monthly salary of S$5,783, and it isn't difficult to see that many Singaporean homeowners will need to use debt (i.e. take out a home loan) to afford property. For those fortunate enough to have extra cash in hand after a few years of homeownership, they may find that paying off the outstanding mortgage may not necessarily be the wisest choice – mainly since the option of refinancing or investing are available.
Can Investing Give You Better Rates Of Return?
Table showing returns from investing in Nikko AM STI ETF vs. total interest paid on loan.
One of the biggest reasons homeowners wish to pay off their mortgage early is that it cuts down on interest payments. The current concessionary interest rate for a HDB loan is 2.6% per annum and anywhere between 1.95% to 2.8% per annum for bank home loans. However, it's worth noting that investing on your own could help you achieve better returns. For instance, you might consider investing in STI ETFs. These are the blue-chip stocks available in Singapore's economy (e.g. DBS Group Holdings and Singapore Telecommunications Limited). The annualised returns from SPDR STI ETF stands at 6% since its inception in 2002, while Nikko AM STI ETF reports a 6.49% since its inception in 2009.
If you have a low-risk appetite, don't worry. There are plenty of low-risk investment options available. A good example would be the Singapore Government Bonds (SGB), where the coupon rates (i.e. yields) can go up to 3.375% per annum, depending on the maturity date.
Investments Offer You Liquidity That Can Bolster Your Finances Whenever Necessary
Table showing how much more in installments you have to pay with a personal loan (3.48%) than with a HDB loan (2.6%).
Another reason you should invest the additional cash on hand is that various investments offer you the benefit of liquidating them when the need arises (e.g. when you unexpectedly lose your job). You could sell off your stocks or bonds, like the Singapore Government Bonds mentioned above, to get back the 'face value' and whatever interest you've accrued on it. Ultimately, it's worth remembering that there’s no point in paying off your home loan early – and then being forced into high-interest personal loans because of cash flow issues.
Should You Pay Off Your Mortgage Early?
Table showing how much more in installments you have to pay with a personal loan (3.48%) than with a HDB loan (2.6%).
However, paying off your mortgage could indeed bring about various unique benefits. You’ll not have to deal with the mental stress of having to fork out a monthly sum from your take-home salary. Also, should the economy recover, interest rates may rise in the future. After all, the historical interest rate for Singapore loans is close to 4%. Another reason you might want to pay off your mortgage early is that doing so could translate to higher cash proceeds when you eventually sell your house. This is because of CPF’s accrued interest rule where if you use CPF to pay for your home, and you sell your house before you turn 55: you will have to 'refund' your OA with what you would have earned if you left that money in CPF.
On the other hand, if you refinance your current home loan (as long as your lock-in period is over), you can opt for a mortgage package with a lower interest rate.
Consider Your Unique Financial Situation When Making A Decision
Ultimately, the choice of whether to pay off your mortgage early, refinance, or invest the sum of money lies with you; you need to assess your circumstance in life to decide which is the right financial decision (e.g. always pay off other higher-interest debts first if you have them).
If you haven’t done so already, it may be worth speaking with a mortgage advisor to understand the terms of your home loan and whether paying it off early or refinancing can help you save money in the long-run.