Why quickly paying off Housing Loan is not wise?

[Dennis Ng]

Why hurry to pay off Housing Loan is not wise?

Sunday Times 29 Oct 2006 page 26 and 27 published an article entitlted]:" Why paying off your mortgage quickly is not always good."

I was asked for my comments. Only some of which were published, below are the full comments I provided to Sunday Times for your easy reference:

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" becos 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 networth.

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 additoinal advantage of having liquidity of your cash which you forgo if you use cash to reduce loan.

[Dennis Ng]

be careful of what you read in internet discussion forum. There's a lot of noise and alot of people who have little knowledge who gladly advise others what people should do with their finances. 2 internet discussion forums I noticed where there're lots of "noise" and "incorrect information" are a funds forum and channel new asia forum.

I came across an internet posting by a Free Lance financial writer with the following comments on this Sunday Times article:

Quote:
Does anyone notice the fine print below the table above? It says calculations based on daily rest. I never heard of daily rest method for mortgage loan before. It is often monthly rest. Don't know is this a typo or there is indeed such a method used by the banks.

End Quote

My comments:

this person does not even know that there're Housing Loans where interest is calculated on daily rest. He even thought it is a typco mistake. My god!!!

And this person I understand has just joined the financial industry and now advising other people on their Personal Finance!!!

It really shows why I keep saying it is very important to choose someone competent and qualified to advise on your financial matters. I'm astonished at his lack of knowledge, yet happily dishing out advice to other people.

[Dennis Ng]

here's what someone wrote at another forum and my comments:

Cheers!

Dennis Ng, http://www.HousingLoanSG.com

i agree with dennis, it took me a while to realise it, but a property loan is the cheapest loan you can get from the banks. so it is a good tool to leverage and frees up some funds for other more aggresive investments in the portfolio.

yup. It was very difficult for me to grasp it at first. Becos since I was a child, my parents always tell me that debt is bad, "don't ever owe anyone any money" were their words of wisdom for me.

When I grew up, again I studied Accountancy and again debt is liability AND is negative. Then I read books on Personal Finance, and ALL the books on Personal Finance, including that of Robert Kiyosaki keep crying the same mantra:"Be Debt Free as soon as possible."

I sort of accepted that as truth until one day I sat down and started calculating, and I started to draw up a Balance Sheet and I SUDDENLY realised that why most people end up retiring with a fully-paid house and very little Cash/CPF is becos most people are so "obsessed" about paying off their Housing Loan. They don't realise that Housing Loan is the cheapest loan anyone can EVER get. And that instead of reducing debt to zero, the way to become wealthier and to move ahead financially is actually to make your MONEY work harder for you!

In the last few years I've been doing that and I now have more than half a million dollars and as I continue to increase my income and SAVINGS and at the same time continue to make my money grow, I'll very likely reach a million dollars in 2 years' time.

Basically, I've practised what I'm preaching and I realised that it is the very same FORMULA that many of my multi-millionaires clients have used to become rich. Most of my clients are self-made and started off very much the same financially as many people out there.

What I showed is that even if you don't know how to invest at all, and you only earn a miserable annual returns of 3.5% a year, you're still better off retaining your Housing Loan. I don't know how else can I show to convince many skeptics out there that what I share has worked for some people (many clients and me), it can work and it will work provided people are willing to un-learn what they learn (ALL Debts Are Bad).

Note: the truth is most debts, especially debt on consumption are bad (that's why banks keep pushing to you). The 2 Most Common Good Debts are Housing Loan (for individuals) and Business Loans (for businessmen).

[Dennis Ng]

below is someone's comments at another forum and my reply:

Cheers!

Dennis Ng, http://www.HousingLoanSG.com

for me, it's very simple.
if you can earn a better return rate than the loan rate, it is a good debt. if you can't, it's better to pay off the loan.

types of people who should pay off the loan :
1. people who can earn a rate better than the loan rate.
2. people who feel better, more relax by not owning money.

My reply:
Actually, if one seriously think about it, it is very difficult for people to FAIL to beat Housing Loan interest rates. Why?

Imagine even if you know nothing about investing. Just putting money into Endowment savings plans give about annual returns of 4% over a 20 years period.

What about crisis? Typically, a crisis comes by every few years and at least once in 12 years. During the last Asian crisis in 1998, DBS's share price was only $5, if someone just WAIT for crisis to invest, he will sure beat the interest rates on Housing Loans. Today, this person can easily sell off DBS's shares at over $20 (or 400% returns over 10 years or annual COMPOUNDED returns of 14.86%.

I have to reiterate that from my observation the reason why many people end up retiring with a fully-paid house and little Cash/CPF are:

1. they commit to buy TOO big a house (more than they can afford).
2. they keep using their Cash/CPF to reduce/pay off the Housing Loan.

They would get ahead financially if they instead FOCUS on making their Cash/CPF work harder for them.

By doing so, it's possible for an average Middle Class Singaporean to accumulate S$1 million dollars by age 40.

Anyone with Cash/CPF now I would advise not using the money to pay one lump sum to reduce your Housing Loan. The next Crisis can be 3 months to 2 years from now and you would then realise it is very easy to make 50% to 200% returns on your capital if you buy during a crisis. I've already shown you past crisis to prove that it had happened before, I am sharing with you actual experience, not classrom theory.

[Dennis Ng]

I agree with your views. Actually, i advocate taking loans for home purchase in sg because the interest is relatively low. One should always keep as much cash to take advantage of opportunities out there.

By staying in an expensive home which is fully paid, you are actually locking in your funds into your home, giving you lesser liquidity for investments and growing your wealth.

definitely.

Why do Rich get Richer and Poor get Poorer?

Becos the Poor cannot understand and do not PRACTISE using Other People's Money to get ahead. The Rich understand and USE Other People's Money to get richer. The Good Debt that almost everyone has access to is Housing Loan, so it is within reach of most people.

P.S. please avoid all bad debt, my definition of bad debt is any debt on consumption is bad and any debt that cannot have a chance of helping you make more money than the interest you pay is bad debt.

I'm trying very hard to educate the public to help as many people as possible to move up from Middle Class to becoming Rich.

However, many people cannot exactly see my point as they can only see one side of the coin.

I think what I can help the world most is to share my knowledge/experience to educate the public so that more people can move ahead financially.

[Dennis Ng]

Below I share with one person's comment in another forum and my reply to him:

maybe you can clear my doubt : do banks have certain obligation to fill in the following case ? --> If the ROI rate is better than loan rate and risk is lower than you defaulting, why do bank want to loan you money, instead they can put into endowment or whatever investment, right ?

yes, you could gain 100%, 200 %, but you could lose, too. it's a double-edge sword like wuiwui said.

My Reply:

Hi hockeng:
Endowment is just an example. I've given other examples.

Well, let me share with you how Banks work. Bank work basically on Using Other People's Money!

Whose money? Depositors' money!!! Yes, the average Singaporean who scrimp and save $500, $1,000, they put in bank and earns miserable interest of 0.25% on saving account and up to 2% on Fixed Deposits.

Bank's Capital Adequacy Ratio is only 8%! What does that mean? It effectively means Bank can use 8 cents of their capital to do $1 business. (that's LEVERAGE). While Poor people would put their $500 in bank to earn 0.25% interest.

That's how Rich Get Richer (bank) and Poor Get Poorer (depositors's interest CANNOT beat inflation, thus their money is shrinking, not growing!)

So when bank lend you money and earn 4% interest rate, it is MORE THAN 4%, becos they are NOT lending you their money. They are largely re-directing Savings by millions of depositors (with a little of their capital) to lend to you. So their profit margin is not peanut 4%.

I will just end here but I hope my brief sharing can show to you that you have many misconceptions about Finance and how loans work, etc, etc.

[Dennis Ng]

Hockeng said:

yes, you could gain 100%, 200 %, but you could lose, too. it's a double-edge sword like wuiwui said.

My comments:
I never, never, never invest my money if the potential upside is 100% and the downside is also 100%. I look for Risk/Reward Tradeoff.

I'm only interested if the upside potential is say AT LEAST 100% and downside risk is MAXIMUM only 25%.

How do I estimate the downside risk?
It all depends on the Asset we are talking about.

Since I used the example of DBS share, let me refer back to it again.

If during last Asian Crisis, when DBS's share price dropped to S$5 and if you look at the Net Asset Value of DBS and the value is say S$4. Thus, you can estimate that this downside ($5 less $4) or 20% is the maximum downside.

What about the upside? Well, you can estimate by using BOTH Fundamental Analysis (eg. you estimate the profits, Asset Value etc) and Technical Analysis (where you read the chart pattern to derive possible upside potential).

Thus, in this case, let's say you estimate the upside potential to be at least $10 (100%), then it is worthwhile to deply SOME Opportunity Fund to invest in DBS when it was trading at $5 in the last Asian Crisis. (Here, the downside risk is 20%, NOT 100%, impossible for 100% downside risk EVEN if DBS collapse and wind-up, it will NOT be worth ZERO.

I hope the above clarifies. As a serious investor, you look for a GOOD Risk/Reward Trade-off. Seasoned Investors are NOT interested in an Investment Opportunity that might have 100% upside potential and also 100% downside potential.

I'm serious. If you do not believe me, go and talk to other seasoned investors.

So now I talk about stocks, people might accuse me of "selling" stocks. Sorry, I'm not involved in marketing of stocks. Once again, it goes to show that I don't write something becos it is related to my business/profession.

[Dennis Ng]

Ever since I shared about "Why Quickly paying off Housing Loan is not wise" I receive overwhelming response.

On the one hand, I have people coming to me thanking me for helping them to "see things in a different light."

On the other hand, there are people coming to me and tell me that there are people who want to pay off their Housing Loan becos it gives them Peace of Mind and they feel more comfortable and financially secure doing so.

As I said, those people who think they are giving themselves peace of mind by paying off their Housing Loan is actually in REALITY doing the reverse (they have less peace of mind and less financial security and comfort) than another person who keeps his/her Housing Loan.

Let me explain why.

imagine 2 persons, one is Mr A and another Mr B. Both have Housing Loan outstanding of S$400,000 and Cash of S$400,000.

In order to have the peace of mind of NOT having any loan, Mr A decides to use his Cash to pay off his Housing Loan and ends up with NO debt (Housing Loan outstanding S$0) and also NO Cash (Cash S$0).

Mr B decides to keep his Cash instead.

Imagine both Mr A and Mr B are the only breadwinners in their family. Supposing tomorrow both of them dies.

Whose family would be Financially More Comfortable and Secure? Is it Mr A's family or Mr B's family?

Now that both of them are dead. If they are able to see their family now, who would have more Peace of Mind? Is it Mr A or Mr B?

This is the reason why I say that people who want peace of mind and comfort and security and becos of that pay off their Housing Loan as fast as they can are actually making themselves less financially secure and having less peace of mind (Exactly Opposite to what they are trying to achieve).

Most people think the earth is flat until Columbus discovered NOT. Many people think paying off Housing Loan is WISE until I started sharing that it is NOT.

What they lack? Financai Literacy.

Why is Michael Jackson who used to earn millions of dollars by singing one concert is now almost bankrupt? Lack of Financial Literacy. The same goes for Mike Tyson (Boxing Champion).

I strongly believe that if people can raise their level of Financial Literacy, it would solve the "Retirement Money No Enough" problem that Singapore is facing. Am I going to ruffle some feathers preaching Financail Literacy? Definitely.

Would ruffling some feathers stop me from preaching Financial Literacy? No.

Of course I know that I cannot convince everyone. However, if I can convince another person and help that person move financially ahead, I will. To that person who becomes financially "enlightened", it will mean all the difference. Do I gain financially from enlightening others? Well, it is difficult to beleive, but it is not the reason/motive for my trying to enlighten others.

[Dennis Ng]

I agree that paying your home loan early may not be a wise move.

However, there is still a risk of financial crisis like 1997 could happen again. At that time the interest rate for some country went up quite dramatically.

What do you opinion on this?

Regards

Hi Ocintop,
if you see a chance for a crisis to happens, the more you should keep CASH and not use precious cash to reduce Housing Loan.

During crisis, one can easily invest in stocks and other investments at half-price and get 50% to 100% returns. Even if Housing Loan interest rates shoots up to say, 6%, I would rather earn 50% to 100% return and pay the higher Housing Loan interest rates.

I'm sharing from my experience.

[Dennis Ng]

do you know that Singapore government has already "warned" that next year's inflation rate can go up to 5%?

When that happens, if you pay say, 4% interest on your Housing Loan, the REAL interest you pay on Housing Loan is actually NEGATIVE 1%, ie. you can Gain 1% in REAL terms by borrowing money!

Below is some information that supports my view.

I like to reiterate again that it is Financially UNWISE for anyone to be in a HURRY to pay off Housing Loan as soon as possible.

Cheers!

Dennis Ng, http://www.HousingLoanSG.com

Rising inflation may be starting to worry policymakers and the man on the street, but it has had an interesting side effect. It has pushed down the real interest rate dramatically and is expected to drive the property market as buyers and borrowers take on more mortgages, which are costing them very little in real terms.

In fact, real interest rates - which a borrower pays after inflation has been factored in - have fallen sharply as prices climb and could turn negative early next year when inflation is projected to hit a high of 5 per cent, economists said.

Some of the biggest companies - which borrow at wholesale rates - are already enjoying negative interest rates, as inflation since September has risen above the key three-month interbank rate.

[Dennis Ng]

What do you think
1. Will Singapore banks increase interest on Housing Loan because of inflation?
( Or will SIBOR or SOR go up because of inflation?)
2.What will happen with your calculations if property price will drop?

Hi Alex,
bank's Housing Loan interest rate typically is linked to Singapore Inter-bank Offer Rate, not inflation rate. Singapore inter-bank rate has remained below 3% despite rise in inflation.

if property prices drop, how would it affect me as an owner? It would only affect me if I NEED to sell the property when prices are low. I bought my HDB Resale Flat in 1995. During the crisis, the market value of my HDB flat went below my purchase price. I was not really affected since I can comfortably pay my Housing Loan instalment throughout the crisis.

Now the market value of my HDB flat has gone above my purchase price in 1995. Again I'm NOT affected unless I decide to sell my HDB flat now and take "profit".

[Dennis Ng]

HDB concessionary rate loan is a Privilege and Benefit given to Middle/Lower Income Singaporeans. If one is not Singaporean, just a PR, one cannot qualify for HDB loan.

Even if you're a Singaporean, if household income exceed S$8,000 cannot qualify for HDB concessionary rate loan. And each qualifying Singaporean only given 2 "chances" of HDB loan (provided 2nd HDB flat is upgrade, even "lateral" movement (eg. sell 4-room buy 4-room flat) one would not qualify for HDB loan.

Thus, in my opinion it is UNWISE for anyone to try to get rid of this benefit by paying off one's HDB Housing Loan as soon as possible. I do not gain at all even if you do not pay off your HDB loan. Just sharing my knowledge as a concerned Singaporean.

Of course others can have a different opinion.

[Dennis Ng]

recently, I've seen an increase in PRs (those middle class PRs, not the high income ones), buying Resale HDB flats.

The reason is that rental rates have easily doubled from S$1,000 2 years ago to S$2,000. However, if they were to buy a HDB flat, typical Housing Loan instalment would work out to about S$1,500 only, and most of it is paid by CPF, not Cash.

Thus, this triggered the increase in such PRs buying HDB resale flats. This might be part of the reason why HDB flats transactions and prices have been healthy in the last few months despite the quietness of the Private Property market.

However, I would caution anyone paying over $60,000 in Cash Over Valuation, as such Prices might not be sustainable, judging from past experience.

If forumers remember, last year I did mention that I expect Landed Properties and HDB flats to perform well in terms of price increase, and the last 6 months' trend and transactions have shown that this view turns out to be accurate.