Personal loans of any kind are traditionally frowned upon, especially by the Chinese. It suggests financial recklessness, lack of discipline and sheer laziness. Even though the financial sector and its loan offerings are nothing like the scene decades ago, many of us still adopt the same mindset as our forefathers. In fact, I had such a tough time shifting the paradigm of two of my close friends that I'm inspired to pen this down.
Being financially prudent is fantastic but financial prudence and loans are not contradictory. Not all loans are bad. I would even go so far as to say that there is a great kind of loan and at this point in time, not maximising it may in fact be financially imprudent. What is this loan I'm talking about? A housing loan. There is a confluence of factors that make a home loan a winning proposition: persistently low mortgage interest rates coupled with relatively high inflation and CPF interest rate.
Low Interest Rate
There is no other type of loan that has a lower interest rate than housing loans. Period.
Not only is the stated interest rate lower than the other types of loans, its amortization methodology is also on a daily or monthly rest basis, making its effective interest rate much lower than the rest. Unlike the monthly interest payment for your car loan, which is computed based on the initial sum borrowed, the monthly interest for your housing loan is computed based on the outstanding balance as of the day (daily rest) or month (monthly rest) of your payment.
Relatively High Inflation
When inflation is higher than the interest rate for your loan, after setting aside your rainy-day stash, it's more sensible to either spend the money or invest it. Why save the money and see your purchasing power dwindle? Only if you do not have anywhere to spend or invest, does it make sense for you to pay down your housing loan.
Relatively High CPF Interest Rate
When the CPF interest rate is generating a higher interest than my housing loan interest, even though I cannot withdraw my CPF monies, I still prefer to keep money in CPF rather than use it to pay off my loan. If I use money from the Ordinary Account to pay down my home loan, not only will I be losing out on the difference between the CPF interest and the housing loan interest, I will also have to pay back from my own pocket the CPF accrued interest if I subsequently sell my property. This is like borrowing money from my own CPF to pay off a lower interest rate loan! There is no hurry to tap on CPF funds as I can always pay down my housing loan subsequently, when my housing loan interest rate goes higher than the CPF interest rate.
As of February 2013,
- Housing loan interest rates are around 1.1% onwards
- Consumer Price Index (CPI) is 4.9%
- MAS Core Inflation Measure (basically CPI excluding property and private transportation) is 1.9%
- CPF interest rate is 2.5% or 3.5% (for the first $60,000 of a member’s combined balances, with up to $20,000 from the OA)