Thursday, November 07, 2013

Paying down your debts or invest the cash?

If you have spare cash, would you dump it to make a partial payment of your mortgage loans or would you invest it so that you can generate more returns? Sooner or later, I think that's the question that you will have to face in your life. The philosophy and the baggage that you carry with you will determine which decision you'll make.


Let's put in the context. I used HDB's loans with interest of 2.6% pa, spanning over 30 yrs. My monthly mortgage, all paid in cash since I have no or little CPF, is about 2k. Each year, based on the monthly mortgage payment of 2k, I would have paid a sum of $24k (2k per month x 12 months). Me and my wife had saved up $24k and I was wondering if it's good to make a partial repayment of our loans. Since the loan is by HDB, there isn't any penalty for early repayments for loans, so this is quite unlike most private bank loans. I guess even bank loans have their own terms and conditions, so penalty for early repayment is not a given; it depends on the contract you've signed on.


Pay down your debts or invest it?


Effectively, if I were to make a partial repayment, that means I'm paying a total of $48k this year - twice as much as I'm obligated to. What's good and bad about this? The good thing is that if I maintain this yearly, I can shorten my remaining 27.5 yrs loan to just 11 yrs. There is going to be huge interest savings in this. The bad thing is that I'll have less cash available for investments. This is especially true for me because I pay off in cash, not using CPF. In other words, I have a higher opportunity cost than if someone pays off in CPF (yes, I know CPF earns 2.5% interest pa and cash inherently has near 0%). What kinds of investments are we talking about? Not just restricted to stocks, but also property.


I've blogged before that I would take the middle path. I would pay off a big portion in the form of partial repayment in my early years of the loan period, until the monthly mortgage becomes 'manageable', before conserving the cash and reserve it for investments/property etc. I've changed the plan a little though. Initially I wanted to make partial repayments and choose the option that allows me to reduce the monthly mortgage instead of the option that reduces the mortgage loan duration. I didn't take into account the fact that the paper work involved for both of them differ. There's a whole lot of paper work that needs to be done to reduce the monthly payment, like changing the GIRO amount, writing in to HDB etc etc. Nah, too much trouble. I'll just tweak my plan to reduce the loan duration initially. When it makes a substantial difference then I'll switch to reducing my monthly mortgage amount.


Anyway, it's not as if all these is going to end in 2-3 yrs. It's more likely going to be an arduous 10 to 15 yrs. Long journey to go, so no point being caught up in paper work every year. Maybe after the 5th year of such repayments, I'll review and see if it makes sense to reduce the monthly amount.


Interest that you owe to others is guaranteed. Investment returns are not. I guess we have to make a compromise between these two.


* After putting in the extra cash of 24k, I noted that I've shaved off 2.5 years off my 30 yrs loan period. A future payment of 1 yr equates to 2.5 yrs of savings from future payments. Hmm, depending on inflation, it might or might not be worth it.


Date: 7-Nov-2013

37 comments :

B said...

Hi LP

For me, I would delay my payments for as long as I can, of course permitting future interest rates and the current investment opportunities.

It's almost the same policy as how a company works. Managing working capital, focusing on cashflow in and delaying payament outflow as long as it permits.

Of course, it still depends on one suitability at the end of the day.

la papillion said...

Hi B,

I guess for this issue, if you ask 2 person, you'll get 3 opinions. May I know your reasons for delaying the repayment of debts? Confident that you can get higher than 2.6% returns pa?

My 15HWW said...

Hi LP,

Even though I am not making lump sum repayments, I do understand my situation is slightly different from yours.

1. The rate on my loan is lower (POSB HDB Loan)

2. I have CPF contributions and they earn higher interest than the loan and can serve as a buffer if I lose my job

3. My monthly mortgage payments are much lower than yours

If I were in your shoes, there is a chance I might make a lump sum capital repayment if I am sitting on some cash and the market is over valued.

la papillion said...

Hi 15HWW,

I guess your intention for getting the POSB HDB loan is to repay back all within 15 yrs or less, am I right? I think we all have different situations and we can only act accordingly to what we deem best for ourselves, haha

It's just interesting that nobody came out in support of paying down debts yet :)

RetireSG said...

HI LP, what are the chances, I was just discussing this with my wife on Wednesday. Exactly the same issue. I cant seem to decide what I would rather do. Both has advantages an disadvantages. I guess there is no correct answer presently. We will only now whether we made the right choice at the end of the repayment period. =X

Patty said...

Paid off mine early for reasons you already know. All I can say is that if you decide to pay off asap, then it is better to start as early as possible since the interest loading is going to be heaviest in the beginning.

When I redeemed my loan in the 8th year out of a 30 year loan, I realize I had already paid over 40% interests if I had stayed the full term.

If I didn't have my urgent needs, I am likely to do nothing to it also. Virtual money right?

la papillion said...

Hi RSG,

Haha, told you that everyone will have to think about this issue at least once in their lifetime if they have a mortgage at hand. Would you be kind enough to blog about how you think about this issue? I'll be interested to know and I'm sure there are others who are in the same situation too.

la papillion said...

Hi Pat,

You're right, most of the early years of the loan is paid to the interest, not the principal sum. I'm still unsure what I want to do in the future yet, so perhaps I'll do this for a couple of year, review and see my situation. For now, I'm tempted to pay off for the next 5 yrs, switch to a lower monthly mortgage amt and let it roll. I'll use the accumulated cash to accelerate my plan for retirement.

15 HWW said...

Hi LP,

I would probably pay back within 15 years if the rates spike up after the "protected" 10 year period.

Maybe if you reduce the tenure pretty fast and the product is still available then, might be suitable for you too!

I have to admit being completely debt-free is likely to be a huge milestone for most people and a target worth striving hard for.

la papillion said...

Hi 15HWW,

Nah, don't think I'll sign up. Things would have changed a lot by then - interest rate environment might be high then, my mortgage loan amt will be much much lower and most of the interest part of the loan would have been paid of. Makes no sense to switch to another loan and start over right? haha

Good for you, if you can pay off your house in 15 yrs. That's a great achievement like you've mentioned. We'll take one step at a time :)

financialray said...

Hi LP,

Now is the time I will start paying off a portion of my debts as property cooling measures make investments less attractive. When there is a crash later (dunno when), I will remortgage if necessary to free up cash to ride the wave. Anyway, since interest rates can only go up, it is better to be at least prepared to pay off part of the mortgage. Didn't the experts say follow the trend? So I just follow what the government is cautioning.

la papillion said...

Hi financial ray,

Hmm, you mentioned something interesting that I've not thought before - that of remortgaging to free up cash. Hmm...

Thanks for the idea, need to think it through first haha!

Anonymous said...

Just FYI....there's no such thing of remortgage for HDB.... Only private can..... So pls rethink again if anyone want to dump CASH into your HDB mortgage loan.... Even if your HDB is fully paid....when in need of money.....ONLY solution is to SELL it..... My advice is really want to dump cash in mortgage loan....make sure not more than 50% of your saving or spare cash....

la papillion said...

Hi anonymous,

Would appreciate if you put a name to your comments, thanks!

Ya, I was musing through that option with my wife after I told her about the comment made by financialray. As far as I understand, can't take an equity loan if your mortgaged propety is HDB.

You're right about paying cash to HDB loan. A few scenarios would make paying cash downright stupid - like not having enough cash to do the monthly payment in the future because I've used up all the cash to pay more in the past.

However, it's also scary that if I don't fast forward the mortgage payment by doing partial capital repayment, I might not have the means to service the loan every month in the future for the next 30 yrs too. It's 2k per month, not a small sum.

It's a balance that I have to find for my own situation, I guess.

sk said...

LP - can lower the monthly payment? if you pre-pay you just reduce the duration of the loan isn't it? the monthly payments remain the same (just that more of the instalments go towards the loan), you therefore save interest on the remaining duration.

la papillion said...

Hi sk,

Yup, you can choose two options - first is to reduce the mortgage duration while keeping the monthly payment fixed, the second is to reduce monthly mortgage payment while keeping mortgage duration fixed. Both will achieve the same effect of reducing the total amount owed.

Can see the options here: http://www.hdb.gov.sg/fi10/fi10325p.nsf/w/MLPartialPaymt

A simple example to illustrate: If you owe HDB $100 over 10 mths (i.e. you pay $10 per month). You pay a pre-payment of $20 and you can choose two options:

a. Pay $8 per month for the next 10 months

b. Pay $10 per month for the next 8 month.

Both end up being the same i.e. you owe $20 lesser from $100.

I wanted to reduce the monthly payment but it's too much paperwork. I'll do it after 4-5 years of such repayments, and it should be much more significant drop to the monthly payment.

sk said...

Nice. Thanks for the information. I was thinking about it a while back - but I would rather have the cash handy/for investment - I subscribe to the view that it does not help networth in the event of a catastrophe since we are insured for 100% under the HPS anyway. But it is the more prudent approach to pay off early and be debtfree/have lower monthly payments

la papillion said...

Hi sk,

Totally understand. I have the same concerns as well. When we have an army, do we attack aggressively or do we defend vigorously? Both are viable options.

I intend to do a mix of attack and defense. For my case, that's putting in 12k to pay off debts, and putting in 12k or more in investment. Review again in 5 years time and adjust the ratio accordingly.

Hopefully I can have my cake and eat it too.

EY said...

Hi LP,

I can fully empathise with your dilemma. :)

I repaid my mortgage loan within 8 years, emptying most of our piggy bank and selling stocks to raise the money.

Some folks would like to look at opportunity costs for a decision like this. Personally, I value having peace of mind more. Life is uncertain and if I can inject more certainty, that counts towards my happiness. :)

Besides, my motivation of investment is to become debt free first, then financially free. Being debt free at 33 years old, I reckoned that I had a good number of years ahead to build on my nest eggs to reach my next goal. I like to settle one thing at a time and not have to juggle too many balls.

Six years on, I have not regretted my decision. I took a 6 month sabbatical in 2010 when I found my job sapping away most of my energy and happiness. I spent the time finishing off my Masters which I knew would provide leverage for finding better employment. If I had a loan to worry about, I would have to work for money and perhaps I might be in IMH now. Seriously.

About investment, I am of the view that if we have more or less learnt the ropes, a 10-15 years horizon is all we need to secure our financial future for retirement after we become debt free. But of course, this is only my humble view. :)

So it really depends on your threshold for managing uncertainty and how comfortable you are dealing with the thought that you no longer have a big investment portfolio or can't afford to grow it for a while. Trust that you will find that balance. :)

Cheers,
Endrene

la papillion said...

Hi Endrene,

Wow, thanks for sharing! Even if I accelerate my payments to HDB, I will still clear it around 15 years, meaning that I'll only finish payment around 45 years old plus minus. I don't think I'll have much time to plan for retirement after I've cleared my debts, so no choice, I'll have to do both at the same time.

1/3 of savings on clearing debt, 2/3 of savings for retirement - that's the plan.

It's really nice to know that you have a good 6 months break. I understand how important it is to take a break from work so that you can re-enter it again with renewed vigor. Otherwise, it's just so depressing.

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