Should I Pay Off My Home Loan?
Buying or Owning?
It’s probably going to make some headlines soon that one bank is offering home loans for a tenor of up to 50 years or 80 years of age. Generally, the initial reaction will be that’s its bad, harmful and wrong. It’ll encourage people to buy properties they cannot afford as by stretching the loan, the monthly installment will be lowered. People may also spend their whole life servicing the loan and will not have any money for retirement. These reactions are well-founded and the intentions obviously good. The reality though is that there is nothing to prevent any lender from offering a loan of such a long tenor if they are willing to take the risk and more importantly, the market has a demand for it.
The interesting question to ask then is for whom will a loan of such a long tenor make sense? Let us give a couple of suggestions. For starters, it may make sense for people who own leasehold properties of 99 years or less. The reason is simple; a 99 year lease is like a 99 year rental because after 99 years, the property will not be worth anything. It would make more sense to pay off a 99 year rental over 50 years instead of 25 years. In fact, in an ideal world, we would all want to stretch it over 99 years! The caveat for this line of reasoning is the cost of paying more interest. Most people today will have some ideas about what they can do with the extra money saved monthly to offset the interest cost but that’s another topic altogether.
Another reason for people to consider a long tenure loan such as this is the use of insurance to offset the interest cost and at the same time, create a bigger estate. For instance, on a loan of $1,000,000, an increase in loan tenure from 30 to 50 years will result in a lower installment of about $1,000 monthly. This $1,000 per month can be used to buy $1,000,000 of whole life insurance coverage for a 30 year old. This will create a few hundred thousand dollars of additional estate for the family upon death after taking into consideration the additional interest cost. This of course requires more planning, consideration and understanding of risks. Don’t try this without the advice of a competent financial planner!
If we want, we can probably explore a few more different options about how to benefit from a longer term loan but we would be missing the real point and that is the purpose of buying a property. For most people, the ultimate goal in buying a property is to own it and until the loan is fully paid, it is the banks that own the property.
Having a carefully thought out financial plan is perhaps the most important part of the purchase and more time should be spent on this rather than the interior design or renovation. This is one of those things you don’t want to take a short cut on.
Here are 7 “Red Flags” to consider:
- Monthly Surplus – If you do not maintain a healthy monthly savings surplus, a change in interest rates will cause difficulties in repaying the installment.
- Loss of Income – It could be due to a critical illness or even the wife choosing to stop work after birth of a child. Such events need to be considered and planned for.
- Loss of growth in income – It could be due to a bad economy or a change in career path, a flattening of income growth will cause stress in keeping up with the installments.
- Rising interest rates – A rise in interest rates will cause an increase in monthly installments. No big deal by itself, deadly when in conjunction with Red Flags 2 and 3!
- Reduction in CPF Contribution as you age – Many people fail to consider the reduction in CPF contribution as they grow older and this may result in the topping up of cash for the installments.
- No plan to pay off the loan – You can’t really retire until you are debt free and many don’t have a plan to pay off the mortgage loan until they’re too old or it’s too late.
- Drop in Property Valuation – If you bought a $1,000,000 property and borrowed based on 80% valuation, the bank will lend you $800,000. If the price of the property drops drastically to $800,000, the bank is only willing to lend you $640,000(i.e. 80% of $800,000). In a situation like this, the bank has the right to ask you to pay down the loan to $640,000 which may result in an immediate need for cash.
We hope you’ve enjoyed this read and if you or someone you know needs a good opinion on their financial plans; we are an email or phone call away! Until we write again, remember to enjoy life the way it should be enjoyed…one memorable day at a time!
Article By Lee Meng Choe, FChFP