There is this question that keeps bugging me which I seldom go and explore. And I believe it bugs some of you as well. If you purchase a HDB flat unit and take out a HDB mortgage loan, **should you periodically put in more to pay off your mortgage?**

### HDB Loan Interest versus CPF Ordinary Account Interest

The common answer I get, and a conclusion I came to myself is: CPF Ordinary Account currently pays 2.5% per annum. HDB Mortgage Loan interest is 2.6% per annum. By paying off the loan, you are saving 0.1% per year the number of years you need to service the loan .

That does not look like a lot. Perhaps, it makes sense to drag it out longer.

0.1% shouldn’t make that big of a difference.

### The dynamics here

Usually what I hear most Singaporeans do will be to take a 25 year mortgage. The longer the tenure the lower amount that they have to pay per month. Since there is no early lump sum additional repayment penalty, they have the flexibility to pay off if they improve their income stream later in their working years.

The** opportunity cost** of paying $X more per month in repayment, is that this $X amount cannot earn the interest it is suppose to earn, in this case the 2.5% CPF OA rate.

For the adventurous ones can also put their opportunity cost that the $X amount cannot be put into higher yielding wealth instruments such as insurance endowment, unit trust, gold , stocks and shares.

The more you put into repayment, the shorter your mortgage tenure, the faster you free up this $X amount to do whatever you want it to.

The more you put into repayment, the more interest you save over the years.

The evaluation here would be how much savings in mortgage interest, versus the returns that a person can get by leaving it in CPF OA, or channeling it in higher yielding instrument over the duration of the mortgage loan.

Year 0 |——————————|————Interest Saved —————| Year 25

vs

Year 0 |—— Interest Returns —-|–Interest Returns on asset build up —| Year 25

### Repaying $1000 more per month

I don’t know why I arrive at this figure, but its a rather well rounded figure.

Our base case is this:

- $300,000 mortgage
- 2.6% per annum HDB loan
- 25 years loan

I am a bit lazy here, so I make use of a trusty financial calculation app. Over 25 years, you will pay $108,303 in interest. So if you buy a $360,000 flat, and want to take a long time to pay, your cost price is not that but $468,303 + Renovation + Yearly Maintenance.

If we pay off an extra $1000 per month, you will save $57,034 in interest and pay off 151 months earlier or 12.5 years earlier. That is a lot of money saved. **Now imagine your opportunity cost is not sitting in CPF OA but in cash, that earns next to nothing. That $57k is like a return on investment in itself.**

~~The opportunity cost in this case of not repaying more is that this $1000 per month or $12,000 per year can accumulate CPF OA interest of 2.5% for 12-13 years.From the table below, the cumulative returns from leaving in OA for 13 years is $25,685. That looks much less than $57k!~~

The opportunity cost in this case of not repaying more is that this $1000/mth or $12,000/yr can accumulate in CPF OA at 2.5% interest for 25 years.

From the table below, the opportunity cost is as if you contribute $12,000/yr for 13 years. For the next 12 years, there will not be contribution but there will be accrual interest, since you have already contribute and build up a base for 13 years.

The cumulative returns at the end of 25 year is **$88,346**. This is much better than the $57,034 in savings.

(Click to view larger)

### Repaying $300 more per month

I was rather floored by the figures. I didn’t think the difference between 0.1% is going to be THAT big. So I decide to do it with a smaller amount of $300 per month. The interest savings are noticeably less at $27,282 and it gets paid off earlier by 70 months or 5.8 years. This means u need to service the mortgage loan for 19 years.

The CPF OA opportunity cost of the $300 per month at the end of 25 years is **$31,572**. This is about $4000 more than if you paid off earlier.

(Click to view larger)

### Repaying $100 more a month

I decide to do the smallest increment that I can think of which is $100 more per month. I won’t go much into it, but the difference is very small here. They are almost equal ($10,971 versus $10,959)

(Click to view larger)

### The opportunity to transfer to CPF SA or higher yielding instruments

The alternative of leaving your funds in CPF OA, is to transfer the funds to your CPF SA, where you will earn 4% and 1% additional for your first $40,000 in your CPF SA.

If you are savvy (or you think you are savvy), you can take the funds and purchase unit trust.

If we take the repaying $300 more per month example, and instead of a 2.5% rate of return but a 4.5% rate of return, the returns at the end of 25 years is $67,853 compare to $27,282 if you paid off the loans faster in 19 years, as well as the returns of $31,572 if you left it in CPF OA.

(click to view larger)

### Some perspectives

#### In most cases, paying more down~~ is~~ NOT better

~~The conclusion I gather here is that all else being equal,~~** it is better to put in more to pare down your mortgage and shorten the duration**. The amount of the difference in opportunity depends very much on the amount you want to repay more. The more repayment, the shorter your mortgage duration, the bigger the difference.

The first conclusion I met when I first published this post is that no matter what, based on monetary figures, it is better to pay off the loans faster. I realize that I didn’t factor in that the alternative of repaying faster is, we build up an asset that accrual interest even after repayment. And as such the returns even at $100/mth matches that of the interest savings.

In most cases, the monetary comparison is better.

#### Repayments using cash yields a different conclusion

The comparisons are done mainly with CPF OA funds but a person can easily use cash to pay down the loan.

In the case of cash, it is a different conclusion because, you are not building up an asset that gives X% returns. Current cash yields very very low. For most folks, if their family members stick to fixed deposits, the better better monetary choice is to repay the loans faster.

The interests saved and not paid will be like return on investments in this case. The difference is not 0.1% but 2.5++% in this case.

#### Repayments are usually in lump sum

This flexibility is great but my simulation **can be said to be a little bit unrealistic **in that, usually the repayment is lump sum. You save for a period and then you pare it down. As such your mileage may vary in the amount of difference between loan interest savings and CPF OA returns. You would have to work it out yourself.

### The evaluation should not be just about monetary

HDB loan like other debt holds different value to different people. Some people can stand having the weight of the debt while others cannot. Your perspective of it influences your decision.

The stability of your job also matters as well. For that it is seldom a monetary only evaluation.

#### Interest Savings is high probable returns versus other wealth building instrument

The alternative to CPF OA is to put in some wealth building instruments. The difference here versus putting more to paring down the loan is that the returns are less probable and that you have to take that into consideration.

#### CPF cannot be withdraw

Even with this evidence, people would not want to pare down because even if they have saved much CPF money, they cannot take out the money. Because of that, they usually compartmentalize and take more risk with it, or not care so much about these little details. At the end of the day, they are not going to see this money.

#### Borrowing 80% loan on second property

If one needs an incentive to pare down their loan is that, if they would like to purchase a second property, but wants to borrow 80% mortgage loan, they would need to pay off their first loan so that the loan on the second property is considered the first loan:

2nd mortgage capped at LTV 60%. There is an increasing number of individuals confused about whether they can qualify for 80% LTV when they already own a property. This rule is for your 2nd mortgage, not 2nd property. So if your 1st private property is fully paid up, you can still qualify for 80% loan to value.

### Summary

What started out as a short exercise on a Saturday after noon became some thing more. I wonder if the majority of the readers friends and colleagues usually drag out their mortgage loans since the loan is considered safe and that they have no assess to CPF. I used to hold that train of thought but in recent years I realize the decision is not so simple as how much you saved, or how much you stand to gain.

When you decide to live your life in a parameter different from others, your decision to pay off or not also will be different. The important thing here is that you go through a sound thought process and come to a good decision.

I would like to thank some of my readers to point out some flaws in my early publication. It turns out that I might not be doing a good comparison in terms of time frame. That is the trouble we bloggers faced. We want to provide our perspective and help educate a bit, but sometimes we have our problems in evaluation and that could cause more harm then good. So I made the necessary correction.

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Mindy

Tuesday 16th of July 2019

Hi all,

Is there a simplified summary which states which is the best method (e.g. pay off with cash then combine with OA > SA topups etc) I got confused with different exchanges of thoughts in the comments sections etc

Thanks & Regards,

Mindy.

JW

Thursday 13th of December 2018

hi bro, im using this app that you used to do some calculations.

if i take a 300k loan, 2.6%, repayment 10 years. mthly $2,841 my total interest will be $41k

if i take the same loan amt and rate as above but change it to 25 years repayment. mthly , $1,361. using the difference in mthly repayment i do a top up of $1,480/mth. my total interest payable is the same 41k.

so m i right to say that it doesnt matter the loan tenure i have took with hdb. as long as i do periodically top up, the interest that i have to pay still work out to be the same.

so it will be better to take a longer loan tenure and pay extra as and when you have extra money. rather than take a short loan tenure and face a high mthly repayment.

Kyith

Thursday 13th of December 2018

Hi JW, i think there is a difference. Usually bank loans or HDB loans are debt amortization. so if you extend the repayment, the total interest you pay should be higher, unless you borrowed less. usually the early repayment pays off the principal. That reduces your interest payment. however, usually it does not reduce the monthly payout unless you restructure it with them.

choon lim

Monday 22nd of January 2018

Hi Kyith, I think to compare both options 25 years, for paying more per month option, it's not fair to exclude the income generation and compounding of those $ free up in in those period after paying the loan.

One way of comparison is like assuming the person has a fixed $2361 contribution into CPF OA for 25 years, then calculate for both options what is the accumulated CPF at year 25.

Option A: Start contributing $2361 from year 12.5 to year 25, final accumulated CPF: $409907 Option B: Contributing $1000 from year 1 to year 25, final accumulated CPF: $409893

Both yields similar return. But CPF OA interest rates increases, then option B will start to outperform due to the larger compounding effect.

Kyith

Sunday 28th of January 2018

Hi Choon Lim, thanks for sharing this. I think I need to rethink this.

Ryan

Monday 31st of July 2017

Hi Kyith,

What is your thought about not redeeming the HDB loan while leaving the money in CPF to gain more interest with consideration of minimum sum and age of the borrower?

Some advice I get if to leave the money in the CPF to prepare for minimum sum in years to come which to be expected to increase futher?

Thanks

Kyith

Tuesday 19th of September 2017

Hi Ryan, Sorry for the late reply. You always have to balance between the math and the qualitative aspect of the decision. In this article, I show the math is that the money in the CPF compounds over time. So it makes sense to drag out the loan. In this way you build up your wealth in CPF. There is no more minimum sum. That term is replaced by Basic Retirement Sum (BRS) and Full Retirement Sum (FRS). And as you mentioned they are going up.

To satisfy the BRS or FRS is not the important and only issue here. the BRS is increasing because inflation is rising and if they do not raise it and it stays at $160,000, when the time comes, most of us do not have enough money in CPF because we spent the money on frivolous things, then is that the right way?

Look at the portfolio of property + CPF as a whole.

eric

Saturday 1st of April 2017

thx 4 e advice :)