Should You Pay Off Your Mortgage Early?
Paying off your mortgage sounds great, but are you making the wisest choice?Here are the pros and cons if you decide to pay your mortgage early.
Paying Off Early
Peace of Mind
Paying off your mortgage is liberating. It provides you with a peace of mind and reduces your stress knowing that you have one less obligation to meet.
Save on Interest
You will also have save a lot in interest. Let’s say if you borrowed $300,000 from HDB at 2.6% interest rate for 25 years, you would have paid $108,303 worth of interest.
However, if you paid off your loan in 15 years, you would only have to pay $62,613 worth of interest.
That’s a saving of $45,690 ($108,303-$62,613)!
Once you have paid off your mortgage, you would have one less expense to worry about! This means you have lesser expenses, which increases your cashflow and you can have more money to invest.
Paying off your mortgage does not provide income unlike investing.
When you make early repayments, more money will be trapped in your house.
That means if you don’t set aside a specific amount in your bank, you will have little to no emergency funds and less cash for other purposes, such as investing.
This only applies if you take up a Bank loan.
You will likely have to pay for an early repayment fee as the bank will lose the interest it could have earned if you didn’t repay your loan early. The amount depends on the bank, which is approximately 1.5% to 1.75% on the loan amount.Here are the pros and cons if you choose not to pay off early
Don’t Pay Off Early
Your mortgage loan amount is fixed and it never changes, this provides a hedge against inflation.
For example, let’s say you are paying $1,000 per month now, 20 years later, you will still be paying $1,000 per month.
As inflation reduces your value of money over time, this means that your $1,000 could be equivalent to electricity bills 20 years later!
Mortgage Interest is Tax Deductible
If you are renting out your property, the mortgage interest is tax deductible.
For example, if you earned a rental income of $3,000 a month, that is $36,000 a year. If your mortgage interest is $10,000 a year, your taxable rental income is $26,000 ($36,000-$10,000).
This is only applicable if your property is generating income.
If you pay off your housing loan early, you wouldn’t be able to benefit from this tax deduction.
If you choose not to pay off early, you would have more money to set aside for your emergency funds, insurance and even invest! Which brings me to my next point.
If you choose to invest rather than pay off your mortgage, you are actually investing with the bank’s money, which is considered leveraging.
Leveraging means investing with borrowed money with the expectation of making higher returns than the interest payable.
For example, if you invested in the SPDR STI ETF, an Exchange Traded Fund that tracks the Singapore Straits Times Index since inception, it would have generated 7.3% per year over the past 15 years, you can use part of that returns to pay off your interest rate from your HDB loan interest of 2.6% a year.
Studies have shown that those who borrowed for long periods of time at low interest rates and invested the rest, they would have ended up with more wealth compared to if they had paid off their mortgage.
Pay Higher Interest
Higher interest expenses is inevitable if you don’t repay your mortgage early. However, you wouldn’t have to worry about this if you are able to generate consistently higher returns on your investment.
If you were to invest instead of paying your mortgage, you have to be very confident that you are able to earn higher returns than your interest consistently.
Although the SPDR STI ETF has generated a rate of return of 7.3% for the past 15 years, there were periods of time where it corrected, such as in 2008 during the global financial crisis where the Straits Times Index loss 58% of its value in less than 2 years.
If the Straits Times Index were to crash again, you are still obligated to pay your monthly loan instalments!
How to decide
Now with these pros and cons in mind, how do you decide if you should pay off your mortgage early or not? Here’s my take.
Pay off your mortgage early if:
- You are confident of saving far more interest than you think you can earn from investing
- You took up a HDB loan which does not have a prepayment penalty
- Being debt free is more important to you than having a large investment portfolio
Don’t pay off your mortgage early if:
- You have high-interest debt like credit card debt, it will be wiser to pay that off first.
- You are savvy with investments and confident that you can make more money by investing it.
- You don’t have time or expertise to invest but you are willing to pay extra fees to hire a professional to invest for you.
Best of both worlds:
Another option that could offer you the best of both worlds is to wound your mortgage. That means make early repayments only for a certain number of years to shorten to the loan period.
For example, if you have a 25-year mortgage, you could repay it till the loan duration is 15 years.
This will help you cut down on your interest expenses and you could still invest a portion of your money.
Every decision has it’s own consequences, so you’ll have to consider every factor before making a decision.
If you need help, you can seek advice from a trusted mortgage specialists, investment advisor or financial advisor.