Buying a home is one of the most important and impactful transactions a person makes in his entire life. However, because it only happens once in a lifetime for most people, people usually don't have a good grasp on the best practices regarding their home mortgages. It's especially easy to forget the nitty-gritty details of how your home loan works few years after you've gotten one. However, just because you don't deal with home loans on a daily basis, it doesn't mean you can just forget about them. There are important features of a home loan that can meaningfully affect your day-to-day finances if you remember to utilise them appropriately and regularly. Here, we reveal 3 biggest secrets about home loans that you have to know if you own or are thinking about purchasing a home.
Don't Use Your CPF to Pay for Your Home or Your Home Loan
By far the most commonly discussed way of utilising your CPF money is to use it to make your down payment or monthly mortgage payment for your home. Since you can pay 10% to 20% of your purchase price with the money that's sitting in your CPF account that can't be withdrawn for a long time, one could potentially justify using this source of capital to help finance his home purchase. However, such a move can actually be economically disadvantageous, if not harmful.
This is because CPF is actually a more expensive source of money than your cash or even a bank loan. For instance, the average cost of home loans in Singapore is around 2% per year. In contrast, your CPF ordinary account yields a minimum of 2.5% per year, if not more. Using your CPF to pay your mortgage instalments, therefore, would be equivalent to borrowing at 2.5% to repay a loan that costs you 2%. The same can be said of using CPF to make even a portion of your upfront down payment, since you are foregoing an investment vehicles that accrues 2.5% per year to replace your cash that doesn't earn any yield. You would essentially be giving up free money that the government is giving you.
Refinance Your Home Loan Every 3 Years
Most home loans in Singapore, especially fixed rate loans, have a term called "lock in periods", which can last up to 3 years. This means that you are locked into promotional interest rates for a few years, during which you are unable to refinance your loan. Banks do this in order to incentivise a certain level of loyalty and stability in their customer base, so that they can accurately forecast their own income stream for the next few years. What many homeowners may forget, however, is that the interest rates on their home loans can spike meaningfully after their lock-in periods expire.
The math is obvious, but it's quite easy to forget this dynamic 3 years after you take out your home loan: it's generally advisable to refinance your loan in about every 3 years, or every time your loan's lock up expires. By refinancing at a promotional lock-in rates before your rate spikes, you can save a substantial amount of money. For instance, let's assume you took out a loan of S$400,000 for 25 years at an initial rate of 1.3%. This interest rate, however, rises to 1.45% from the 4th year of the loan. If you were to compare keeping this loan to continuing to refinance at 1.3% every 3 years, the difference in interest is almost S$9,000.
Of course, banks have every reason to discourage you from refinancing so aggressively. In order to do this, they've introduced various measures like early repayment penalties, and pricing reset date penalties. However, the banking industry is competitive enough that banks are also providing various cashback and subsidies to offset some of the costs involved in refinancing to lure customers away from their competitors. As long as you are savvy about avoiding some of the fees and utilising subsidies, you can stand to gain substantially.
Instead of Rushing to Repay Your Mortgage, Consider Re-Capitalising Your Home
Most people have a natural urge to clear one's debt as quickly as possible. When it comes to home loans, however, repaying early can actually be a money-losing proposition. The reason is that home loans offer some of the cheapest cost of capital in the country. Instead of repaying a loan that only charges you 2% per year, what if you used that money to invest in stocks and make 5-10% per year?
You can do just that by re-capitalising your home with additional home loans. As an example, let's say a person bought his home at S$500,000 with S$400,000 of mortgage. After 10 years, he has paid back S$140,000 of his loan, increasing his home equity from S$100,000 to S$240,000. If he were to recap his house to re-borrow that S$140,000, he can invest that fund to earn a lucrative return, more than enough to offset the cost of his loan. Even if he made 6% per year only, he could make over S$27,000 in profit compared to just S$8,000 of interest cost. This doesn't even account for the fact that the interest you pay on your home loan are tax-deductible, so they aren't as expensive as you perceive them to be.
Home Is Your Most Important Financial Asset
Although you may have not thought this way before, home is actually a financial asset, and likely the biggest one in your possession. Even if home prices aren't particularly hot, you can still apply some of the concepts we described above to increase your wealth over time. The key is to understand that debt is not necessarily a bad thing, and home loans in particular can be a cheap source of capital that you can use for other value-creative activities. To do so, try to avoid using your CFD when you are considering buying a new flat or condo, look for the best housing loan not only with the lowest interest rates, but also with the flexibility to allow you to refinance easily, and actively look for opportunities to return to the debt market.