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*Home > $avvy* Blog Corner > Why it’s not Wise to Hurry to Pay Off Your Housing Loan**
Why it’s not Wise to Hurry to Pay Off Your Housing Loan

posted by Dennis Ng on 19 Sep 2009 2:22 PM

If you read any Personal Finance books from all bookstores, one "recurrent" advice they have is "be debt-free as soon as possible". I have seen many people after reading such books quickly pay off all their debts, including Housing Loan, which to me is actually unwise.

They forget that there is GOOD debt and there's BAD Debt. Bad debt is any debt on consumption. Thus, to me car loans, personal loans, credit card debt are ALL bad debt and a person should avoid such debts or aim to pay them off as soon as possible.

Actually, if there's a way you can be "debt-free" and yet enjoy the benefit of leverage that debt provides wouldn't it be better? It can be done, let me show you how.

Personally, my Housing Loan is $x amount. What I have in cash is more than $2x. So am I debt free? Actually on a NETT basis, I am. However, I'm "retaining the Housing Loan debt" because it makes financial sense to do so. In my opinion, the problem is most people only have a limited knowledge and finance and debt but they just stick to concepts such as "be debt free as soon as possible" without looking at the issue deeper.

They never think deeper, such as how you can "be debt-free" but still enjoy the "Leverage" that debt provides (just like what I'm doing). Isn't that better? It's likely having your cake and eat it too.

Not doing what I am doing is "shortchanging" yourself.

As I mentioned, as long as a person does not over-borrow, (ie. debt servicing ratio less than 35%), he can just aim to pay off Housing Loan by age 55 and not in a hurry to pay it off.

Why? Here’re the reasons:

1. Housing Loan is cheapest loan a person can ever get. Currently, Housing Loan interest rate is about 3%, compared to 7% for car loan, 14% for personal unsecured loan and 24% for credit cards!

2. Paying off Housing Loan does not increase your net worth.

Let me use an example to illustrate:

Mr A owns a condominium with a market value of $500,000. He has an outstanding housing loan of $400,000 and no other liabilities. He has other investments worth about $100,000 and has $100,000 in cash/CPF Ordinary account balance. He is considering to use the $100,000 in cash/CPF fully to reduce his housing loan from $400,000 to $300,000 after reading books which “teaches” him to be debt-free as soon as possible. Will doing so really improve his net worth position?

This is his current Net Worth Position:

Assets:

Cash/CPF $100,000

Other investments $100,000

Property (market value) $500,000

Total assets $700,000

Less total liabilities:

Housing Loan $400,000

Net Worth $300,000

By using his cash/CPF to reduce his housing loan, this would be his revised net worth position:

Assets:

Cash/CPF $0

Other investments $100,000

Property (market value) $500,000

Total assets $600,000

Less total liabilities:

Housing Loan $300,000

Net Worth $300,000

As you can clearly see from the above example, using his cash/CPF to reduce his housing loan, he is simply reducing his asset to reduce his loan. The net result of doing so makes no difference in his net worth position, which remains as $300,000.

3. By reducing your Housing Loan, actually you’re reducing your “Financial Security”.

What are the 3 worst things that can happen to anyone?

They’re :

- death
- disabled
- retrenchment

in all 3 worst scenarios, the person who did not use up his cash/CPF to reduce loan, his dependants would actually be in a better financial position than after he reduces his loan.

If he take up mortgage insurance, his housing loan would in fact be paid off by insurance in event of death and total permanent disability. Thus, by reducing his loan, he is just reducing his own benefit from mortgage insurance.

4. You can actually gain financially by keeping your housing loan!

As I have shown in the detailed spreadsheet calculations of $100,000 loan vs $100,000 savings.

5. Opportunity cost of using cash to pay off Housing Loan

As mentioned, I hold about 30% cash currently. If next year, U.S stock market crash due to correction ins U.S. property market, I would be able to benefit from a “crisis” because I have cash to invest when prices are low. People who use cash to reduce loan has NO cash to take advantage of opportunities in a crisis.

People say “crisis is an opportunity”.

It’s wrong. I say, a crisis is only an opportunity to those people who have cash. A crisis is NO opportunity for people who do not have cash to invest. When a crisis comes, I can easily make 50% to 100% returns. Just take a look at past crisis eg. SARS in S’pore in year 2003 and you would know what I say is the truth.

6. You can easily get 3% to 4% annual returns single premium endowment even if you don’t know how to invest.

For people who say they don’t know how to invest their money, that’s why they use cash to reduce loan. My reply to them is just take up a 20 year single premium endowment and you can easily get annual returns of at least 3.5% per year. (just get any quotation from any insurers in Singapore and again you know I’m speaking the truth.

7. Instead of using cash to reduce your loan, you can take up "Interest Offset Loan". By doing so, you're not paying interest since the interest earned on your cash 100% offset interest you pay on your loan. You enjoy the same advantage as paying off your loan. However, you have another additional advantage of having liquidity of your cash which you forgo if you use cash to reduce loan.

Category: Housing | 28 Comments

28 Comments

romanzick commented on 2011-03-26 9:02 PM

I want to mention that this post really forced me to do so. Really nice post! good job .. i like it!

juicy couture commented on 2011-02-21 9:51 AM

This post appears to have a great deal of visitors. How did you advertise it? It has a nice unique spin on things. I guess having something authentic or substantial to talk about is the most important thing.

Betty commented on 2011-02-18 7:33 AM

I feel enlightened. Thanks for the useful post.

Chan Siu Fai commented on 2010-11-06 11:21 AM

My personal thought: Both Mr Dennis Ng and Mr Lazy are not wrong. It depends how risky an indiviual is. One will never knows if the market suddenly turn to/against your favour. I also did some investment: just before the 911; (Guess you all know what happen after that) But it did not stop me from investments. I went into stocks during early 2009 and WOWLA; i was REWARDED. But for me, i do think one must not only work hard, but also had to save and do some investment.

lazy commented on 2010-08-16 5:06 PM

This is an old post but i think it worth discussing about and i am here to offer some questions/opinions. Pardon for the long post.

I agree for companies, the current financial business model is a game of leverage + buffer to ride the hard times. When i say this, i mean that companies will gladly borrorw to finance that new investment(and the implict assumption is that investment has good reliable returns ) if the cost of borrrowing does not present additional financial burden to the company and is cheaper than WACC.

To use this concept in corporate finance and advocating that this same principle be applied to personal wealth management is NOT entirely sound.

The reasons are because company is significant different from a person.
A person has differing goals at different times

By the way, here are some of the key difference to highlight difference between company and individual.

1. A company can go belly up in financial crisis. End of story. But the individual will need to carry on with life when faced with financial crisis and whatever that means to carry on. As such the buffer needs to very very high. By the way, there are also dependents to think about.

So , in financial crisis, it makes perfect sense for individuals to reduce all loans to a min rather than go play with investments.

2. A profit orientated company is in the business of seeking greater returns and continued profitability. Individual can be contented to remain at very low growth rates and especially in retirement, it is more of the case of just keeping a certain lifestyle to the end.

3. A company needs to invest constantly but individual does not. It is NORMAL for networth of an individual to go down. Why hoarde after increasing networth unless that is your life goal ?

So back , individuals should seek to be debt free unless you have no dependents and and you believe that your investments will always be > returns in your debt.

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