Pros and cons of paying off your mortgage early

With mortgage interest rates in Singapore on the rise, homeowners are starting to wonder if making full payments on their mortgage loans ahead of schedule is a smart way to save. While the basic answer is yes, the financial management style and goals of homeowners can make the answer less straightforward.

At times, the amount of interest saved from repaying a home loan early might not be more than what could be earned if the funds are invested in other asset classes. There are also many pros and cons that must be reviewed closely before deciding if paying off a mortgage early is a beneficial option.

Before you decide to raid your savings to pay off your home loan in Singapore, you must first get clear about how much mortgage interest you are paying because it underpins your total home ownership costs.

How to calculate your mortgage interest in Singapore

Calculating your mortgage interest is an important step because the result determines if making full payment on your mortgage can let you save on your total home loan repayment.

In Singapore, mortgage interest rates are calculated using the loan amortisation model, also known as the reducing balance model, which spreads the principal loan sum plus interest across the entire loan tenure in a series of fixed payments.

The monthly loan repayment amount is tabulated based on the outstanding loan amount at the end of each month, multiply it by the agreed interest rate, then divide that amount by 12. Assuming you have a $500,000 mortgage loan for a residential home in Singapore and your mortgage interest rate is four per cent, your interest payment for one month would be:

Monthly repayment	S$2,387.08
Total interest payable	S$359,347.53
Total amount payable in 360 payments	S$859,347.53

If the same loan sum is payable over 30 years (360 months), you can easily determine your repayment breakdown using a mortgage calculator and the result will look like this:

What if the interest rates increase from four per cent to 4.5 per cent?

Monthly repayment	S$2,533.43
Total interest payable	S$412,033.56
Total amount payable in 360 payments	S$912,033.56

The 0.5 per cent difference immediately triggered an increase of $146.35 for monthly repayment and $52,686.03 for the overall amount payable. This explains the importance of scouting around for a home loan in Singapore with lower rates because even the smallest difference can amount to hefty costs.

In the current economic climate where rising Fed rates are pushing mortgage interest rates to go up in Singapore, it makes absolute financial sense to pay off as much of your mortgage loan as possible to avoid incurring more interest.

Even if you cannot afford the full payment on the loan, an increase of a few hundred dollars on monthly repayment can also reduce the total amount payable quite significantly.

For example, by paying an extra $200 per month against your principal sum, your $500,000 home loan with four per cent interest can be shortened from the initial 360-month tenure to 311 months. This increase in monthly repayment will also reduce the total interest payable by $55,914.70. It is quite a lot of savings in the long run!

Monthly repayment	S$2,387.08
Total interest payable	S$303,432.83
Total amount payable in 311 payments	S$803,432.83
Source: Mortgage Calculator

Pros and cons of paying off mortgage early

Paying off the mortgage is a dream come true for many homeowners. However, before you go ahead to settle your mortgage before the loan term is up, there are some pros and cons that you need to take into consideration.

The pros

• Free up your funds so that you can channel them to other investments or activities
• Reduce your overall home ownership costs by cutting down mortgage interest
• Allows you to tap the equity in your home if you need money in the future
• Peace of mind and freedom to restore work-life balance since you no longer need to stress about mortgage debt

The cons

• You may not have the excess funds to take advantage of investment opportunities that offer higher returns
• Most banks impose an early loan redemption penalty that goes as high as 1.5 per cent of the outstanding loan sum. However, a precise calculation may reveal that it is worth paying these fees
• If the market drops suddenly, you may not profit as much as you hoped if you need to sell it quickly

Ways to pay off mortgage early

If you have evaluated the pros and cons and are still keen to pay off your mortgage before the loan term is up, here are three strategies that you may consider.

1. Make extra monthly payments

Paying extra money against the principal every month or making an extra principal-only payment annually can easily save you large sums in interest over the life of the loan.

Taking the earlier example as a reference, paying an extra $200 per month on a $500,000 home loan with four per cent interest significantly reduces the repayment period and cuts down the total interest of the loan by $55,914.70.

	Scheduled Payment	Pay an Extra S$200 per Month Against the Principal
Monthly repayment	S$2,387.08	S$2,387.08
Accumulated interest	S$359,347.53	S$303,432.83
Total amount payable	S$859,347.53 (paid over 360 payments)	S$803,432.83 (paid over 311 payments)

2. Refinance the mortgage

Refinancing your mortgage is an ideal strategy if you can get hold of a mortgage deal at a lower interest rate or with a shorter loan term. Selecting a shorter term may mean you have to increase your monthly repayment sum but it can help you pay off your mortgage in Singapore at a faster pace. Imagine replacing your 30-year loan tenure with a 20-year option. You will not only be able to claim home ownership earlier but also attain financial freedom at a younger age.

3. Make a lump-sum payment

If you manage to get your hands on a sum of money through a sudden windfall, bonus at work or inheritance, this strategy may work well for you. This method allows you to pay down your loan by a large chunk and consequently reducing the balance and interest charged. However, do note that most banks do impose a fee for lump sum payments that affect the initial lock-in period.

Conclusion

If you intend to pay off your mortgage early, you must first get clear about your financial status and how much funds you can fork out every month to repay your debts. Being able to pay down your loan quickly can be liberating but it may not be beneficial if it generates more mortgage stress. Speak to a trusted financial advisor to assess your affordability if you are unsure.

ALSO READ: Are you paying more on your home loan than you should?

This article was first published in ValueChampion.