Updated: Oct 21, 2021
Those housing loans sure are pesky! With the prospect of a large quantum sum hanging over our heads for many years, we can be tempted to use any and all cash resources we can spare to pay off our housing loans as soon as possible. Yes, this may prevent the loan from accumulating interest, but is this really the best approach? Should we pay for our homes in full at the first opportunity? Read on to find out!
Case 1: Paying for a property in full
Let’s imagine you have just found a lovely condominium apartment, one that seems to be a perfect investment in almost every way. Except that its selling price is a whopping one million Singapore Dollars, with a 3% buyer stamp duty (total buying price = $1,024,600). But wait – even though you would not normally have 1 million SGD on hand, you have somehow come across a windfall, and can just afford to pay off the property. What a relief! So you pay the buying price in full immediately and enjoy your new property, with housing loans being the furthest thing from your mind (remember – you paid in full, so you don’t have any outstanding housing loans and no interest accumulated). It’s a great apartment, so let’s assume that for the next 10 years (120 months), you have tenants who are willing to pay $3000 a month to rent the property; a nice, steady flow of income for you (total rental income = $360,000 over 10 years).
Now, after 10 years, someone has made you an offer on the property of $1.2 million, a good $200,000 more than the price at which you bought it. Of course, you would have to pay maintenance fees over the years, and let’s say this cost you about $300 a month on average (total maintenance costs = $36,000 over 10 years). With the $360,000 from rental, you’d be making a profit of almost $500,000 on your initial investment if you accept the $1.2 million offer! Because your total investment in the property is your buying price and your maintenance cost, when you take into account your gains from the rental income, a profit of $500,000 gives you a return on your investment of over 70 percent! Not too shabby at all for a 10-year investment.
Case 2: Taking a loan
But what if you choose not to pay for it in full at the first opportunity? Well, then you’d have to take a housing loan. The maximum loan you can take is 75% of the buying price, so that would be $750,000 at a 2% fixed interest rate. Because of that, the initial capital you channel into the property would only be $250,000 ($274,600 with the 3% buyer stamp duty fees). Of course, you’d have to pay monthly loan repayments with interest at about $2772.15 per month (loan payments = $332,658 over 10 years). Given the same rental income of $360,000 and maintenance fees of $36,000 and the same $1.2 million offer after 10 years, this puts your return on investment at about 130% – much more than if you’d paid for the property in full! This is because you’ve locked much less of your capital in the property for the 10 years you owned it.
What about outstanding loans?
“Wait!” you may be thinking. “What about the outstanding loans that have not been paid at the end of the 10 years? After those are paid up with interest, wouldn’t we wind up with an investment value of higher than in Case 1?” Well, you are right! In case 2, you would wind up with an outstanding loan of about $547,981. And it’s true – after you pay back that loan, you’d have channelled more money into the property than if you had paid in full in the first place. But keep in mind that the good thing about not paying for your property in full is not about absolute numbers, but about opportunity cost. You see, in Case 1 when you pay in full, the full million dollars is locked in the property for the entirety of the 10-year duration! Sure, it keeps housing loans from accumulating interest, but this also means the money can’t be used anywhere else.
What if, for example, the property is sold at a loss for, say, $900,000? The interesting thing is, even though case 2 would give you a smaller ROI (about 24%) compared to case 1 (about 28%), both still have positive ROIs despite the much smaller initial capital that was put in for case 2. Which means that leveraging could help you make money even in situations where the property is sold at a loss.
Where should I put my money?
On the other hand, when you don’t pay for your property in full, the money you have to spare from that million dollars can actually be put to work elsewhere. For housing loans in Singapore, interest rates tend to be pretty low (only about 2 percent), so instead of pumping the spare cash from your windfall, it might be better to pay off other debts that may accumulate interest at higher rates. An outstanding credit card bill is just one example of a loan where the interest rate is likely much higher than a housing loan.
Even if you have no outstanding debts to be paid, using your spare cash to pay off housing loans may not be the best way to invest your money. Because interest rates from housing loans accumulate at such a low rate, putting your money to work elsewhere can potentially be more lucrative for you in the long run, take for example investing in a 2nd property where it can potentially make you way more capital than to save on that 2% mortgage loan interest.
Keeping your options open with spare cash may not be the worst thing in the world right now either – this gives you a fallback plan if unexpected payments and situations should arise over the years. As this year has done an excellent job of showing, life can be unexpected sometimes. The CoVid-19 situation definitely had a huge financial impact on many countries, including Singapore, and having a safety sum can help you prepare for difficult times like this.
In conclusion, paying for your property in full at the earliest chance we get does have some benefits, and it does keep your housing loans from accruing interest. However, if you look at property as an investment, you need to maximise your leverage. So it makes sense to channel only a small portion of your spare cash into your property, and use that little investment to make more money for you over the years. Plus, in the meantime, the money you didn’t use to pay off your home can make even more money for you in other investments!