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Should You Pay Off The Loan For Your Home?

Why you should not pay off the mortgage for your current home

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So you have additional savings and thinking whether to pay off your mortgage?

Well if you don’t have any plan to invest your savings (cash or CPF) in another property or other forms of investment in the future, and plan to stay in the same house for the next 30 years, well then technically you should consider paying off your mortgage faster to reduce the loan interest payment. And if that’s the case, you may be better off paying the mortgage in cash, and allow your CPF to build up at a compound interest of 2.5%.

However, if you have options for future investment, then below are some illustrations to show why you should not pay off more mortgage for your current home.

 Case Study: 

  • Property price = $800k.

  • Assume if we just stay for 5 years. And experience a $X capital appreciation.

  • Assume 30 years loan at 2.2% interest rate.

The 2 scenarios below illustrate how the varying initial capital outlay affects our Return On Investment (ROI).

Scenario 1: Captial Appreciation of $100,000. 

 1. $200k down payment.

Interest for the first month is about $1.1k out of the $2.3k monthly mortgage. Interest drops to $965 at the end of the 5th year. Total interest is about $62k over the 5 years. Total principal paid over the 5 years is $75k.

ROI = ($100k – $62k) / ($200k + $62k + $75k) = 11.3% over 5 years

 

2. $200k + $50k = $250k down payment.

Interest for the first month is about $1.008k out of the $2.088k monthly mortgage. Interest drops to $885 at the end of the 5th year. Total interest is about $56.8k over the 5 years. Total principal paid over the 5 years is $68.4k.

ROI = ($100k – $56.8) / ($200k + $50k + $56.8k + $68.4k) = 11.5% over 5 years

 

Here the ROI, albeit slightly, tells us that it’s better to pay off more loan.

 

Scenario 2: Captial Appreciation of $150,000. 

1. $200k down payment.

ROI = ($150k – $62k) / ($200k + $62k + $75k) = 26.1% over 5 years

2. $200k + $50k = $250k down payment.

ROI = ($150k – $56.8) / ($200k + $50k + $56.8k + $68.4k) = 24.8% over 5 years

 

Here the ROI tells us that it’s better to pay off less loan.

 

Seems that whether paying more is better or not depends on the time frame we are staying and the market that will determine our capital gain. Challenge is that usually it is unlikely for us to pinpoint our exact plan in the future.

 

Better Way To Look At It

So it is more advisable to examine the entire system instead of just on the property we are staying. For instance, for the first example of $100k capital gain, assuming now we have additional $50k at our disposal, we can potentially have 2 options.

1. Pay off more loan resulting in better ROI of 11.5% (vs 11.3% if we pay off less loan).

2. Leave the $50k in the CPF or if its cash we can invest in low risk investments first while we save for an investment property. For example, if we just leave the $50k in CPF and get 2.5% return compounded for 5 years, that will give us $6570 return at the end of the 5 years.

ROI of the whole plan = ($100k – $62k + $6570) / ($200k + $62k + $75k +$50k) = 11.5%

 

The second option ROI actually match the first option ROI. But it gives us the future option to invest in another property early, rather than having the cash/CPF tied in the first property.

 

*Note the calculation is just an estimate for illustration purposes.

 

Depending on individual circumstances, they will call for different solutions. The above examples are not rules but rather they aim to help to open your mind when exploring your options, to help you make a better decision.


Happy investing 🙂

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