Being debt free

Paying off your housing loans
A colleague once consulted me on whether she should use her CPF to pay off her housing loans above and beyond her monthly mortgage instalments deducted from her CPF ordinary account. Whether you should pay off your housing loans depends on many factors. Some of these factors include:

1) Type of loan -- HDB vs. Commercial Bank
2) Interest rates
3) Financial planning


1) Type of loan -- HDB vs. Commercial Bank

a) Assumption: Loan quantum is the same amount as CPF savings

The type of loan you have taken makes a difference in terms of whether you should consider paying off your loans as quickly as possible vs delaying it. If you are on the concessionary HDB loan rate of 2.6%, your current CPF ordinary account savings pays you an interest of 2.5%. This means that your loan interest rate is higher than your CPF ordinary account by 0.1%. Now assuming your loan quantum is the same as your CPF ordinary account balance, then you incur a net expense of 0.1% by not paying off your housing loan using your excess CPF ordinary account monies.

Verdict:
Hence, if you cannot get any better return than 2.6%, you should use your CPF ordinary account monies to pay off your loan.

b) Assumptions:
Loan quantum is the same amount as CPF savings + You can get a better return than HDB loan rate of 2.6%

If you are able to get a better return from investing your CPF ordinary account monies into stocks and shares or other investments and your loan quantum is the same as your CPF ordinary account savings, then you can consider paying off your loan slowly and getting a better return. For those of you who are familiar with investing, you will know that to consistently obtain a return higher than 2.6% without risk is rather difficult. Prices of stocks and shares can go up and down and sometimes to the tune of 5-20% within months, weeks or even days! Hence, this volatility makes it tough. If your investment knowledge does not go beyond fixed deposits and you cannot tell the difference between a treasury bill and a time deposit, I would suggest that you consider paying off your loan with spare CPF ordinary account monies as it would be even more difficult for you to get a risk-free return exceeding 2.6%.

Verdict:
Hence, if you can get a better return than 2.6%, you can consider investing your CPF monies in investments that yield higher than 2.6% risk-free.

c) Assumptions:
Loan quantum is more than CPF savings + You can get a better return than HDB loan rate of 2.6%

In this scenario, things get a bit tricky. To decide whether you should pay off your loan with excess CPF monies depends on whether the total returns from investing your CPF ordinary account exceeds the total interest expenses you have to pay on your outstanding loan quantum.

Let's say loan quantum = $150,000
Loan interest is 2.6% (HDB concessionary rates)
Investment returns = 5%
CPF ordinary account balance = $100,000.

Total interest paid for the year (using simple interest) = $3,900
Total investment returns = $5,000.

Hence, if you can get a return of 5% on a CPF ordinary account balance of $100,000, then it makes sense. However, if let's say the investment returns is = 2.4% (treasury bill risk free rate), then

Total investment returns = $2,400 < style="font-style: italic;">Verdict:
You need to calculate expected returns from investing vs expected interest costs to decide if you should use CPF ordinary account monies to pay off your loan.

Note:
The Government has announced that the CPF ordinary account balances for the first $20,000 will be paid a higher interest rate of 1% above the statutory minimum of 2.5% currently. In addition, the SMRA (special, medisave and retirement accounts) on the next $40,000 will also attract a higher interest rate of 1% above the long-term bond rate which will be pegged at the 10 year Singapore Government Securities (bond). This should be factored in for your own calculations whether you should pay off your loans using your CPF ordinary account monies.


2) Interest rates
Generally commercial banks rates of interest are much higher than the concessionary HDB loan rate of 2.6%. Prime is around 4-5% and the above illustrations also apply except that you would need to get a better return than 4-5% to leave your CPF ordinary account monies in your CPF. that is what I did for my own loan. I used my excess CPF monies in the ordinary account to make partial capital payments of my loan because the interest on my tloan at one stage was at 4%. Hence, unless I could obtain a risk-free investment using my CPF ordinary account monies that exceeded 4%, I saved on the loan interest by making capital repayments.

Some people have feedback to me that their CPF monies are used as a buffer in case anything happens to them. In addition, those who buy HDB have the dependents protection scheme where the HDB apartment loan will be paid off should anything untoward happen to them.

Verdict:
In general, commercial bank loans after the 1st few years of concessionary rates tend to be much higher than your CPF ordinary account savings rate. Hence, in most cases, if you have a commercial bank loan, it is better to pay off your loans faster as banks can raise their interest rates unilterally after the lock-in period especially if your loan is a floating rate type.


3) Financial planning
In this article, I have not even touched on using cash in addition to CPF ordinary account monies to pay off housing loans early. The argument for using cash is similar, i.e. cash yields only 0.25% in savings account, up to 2.7% for longer term fixed deposits (2 years). Treasury bills yield around 2.4%. Thus, to find a return that is higher and at a risk-free rate above your loan rate is challenging especially when it is a commercial loan.

My strategy that has paid off was to channel virtually all my CPF ordinary account monies that was not already going towards paying off my monthly mortgage instalment into periodic year-end partial capital redemptions of my outstanding loan. I also channeled spare cash from year-end bonuses, windfalls etc into paying off my loan early. Whatever present consumption I could defer I deferred. E.g. not buying a car and using public transport. Keeping my living expenses low and living way below my means. But doing this consistently over 12 years, I have managed to pay off my mortgage and am debt free!

Some people might find my approach to life and living somewhat austere. Some feel it is existing but not living. I guess the key that differentiates myself from others in this regard are my views on present vs. future consumption. I grew up in a frugal family and inherited this approach to spending and saving. Thus, it was obvious to me early on in my career to take a lower loan quantum and to defer much of present consumption to the future by utilising cash and CPF ordinary account monies into paying off my housing loans.

This strategy works for me because I live a relatively simple lifestyle. Thus, I value financial freedom and that ability not to worry about my job because I have prioritised first paying off the largest debt -- housing loan first before consumption. I am fortunate that my spouse also shares this philosophy and we make do with the simple things in life.

My home is the biggest investment in my life as it provides me with a roof over my head and it also stores us part of my wealth given Singapore's growing inflation rate. Staying in my owner-occupied home helps me to save on rental expense while paying off my loan quickly helps me develop a positive net worth position quickly and makes me financially less stressed.

At the end of the day, each of us has to decide how we manage our debt. Like fire, debt is a good slave but a bad master.

Be well and prosper.