Should you pay off your existing home loan in 2023?

In 2023, mortgage interest rates are a key concern. This is a steep difference between the tail end of 2008 to 2021 when the average interest rate seldom broke past two per cent (it’s three per cent and climbing at the moment).

This has led to questions on whether (for those who have the means) they should go ahead and pay off their remaining mortgage. Here’s our answer:

The general answer for most people is going to be no

Many (but not all) people will find that paying off the entire mortgage at once has little benefit, and just results in a loss of liquidity. The rationale goes something like this:

If you owe $300,000 on your remaining home loan, and you have $300,000 in cash, your net position is: ($300,000 cash) – ($300,000 debt) = $0

If you repay your entire existing home loan, your net position then becomes:

($0 cash, as you’ve repaid the whole loan) + ($0 debt) = $0 

However, the former is in a better position than the latter. The reason is that in the former, you have cash for various emergencies and opportunities. If you have zero debt but also zero cash, you could face a liquidity issue if you run into a crisis.

In an emergency, this could force you to sell your home, or use alternative forms of credit (e.g., personal loans) which end up being far more expensive than your mortgage ever was.

Do also note any redemption penalties involved that can add to your cost

For instance, if your package expires you are likely to not face any charges. But if you’re still in the lock-in period, you typically will be charged 0.75 per cent of the remaining loan upon sale or 1.5 per cent of the remaining loan if the full redemption is done.

There is also the issue of being able to invest in other assets

By not paying off your loan in full, you have sufficient cash to invest in other assets like stocks, bonds, etc. We don’t dispense financial advice with regard to that – but if you speak to some financial professionals, we’re sure they’ll highlight some investment options that could easily outpace your home loan interest rate. 

This is also a matter of diversification. 

If the entirety of your wealth is locked up in a single asset (in this case your property), you’re at serious risk during a property downturn. It’s not a very balanced approach. So for most people, it’s probably not advisable to throw every last cent into their home, to pay off the mortgage early. 

That being said, some people could benefit from paying off their mortgage early. Some examples of this include:

• Borrowers with a small outstanding loan
• People unable to secure mortgage insurance for any reason
• Anyone intending to purchase a second property
• Homeowners with debt-anxiety

1. Borrowers with a small outstanding loan

If your loan amount is too small, banks usually won’t consider refinancing (even if they did, the fees involved may not be justified). As such, some borrowers who just have a small amount left to clear may want to do so, before interest rates rise further. 

The tricky bit is that what’s “small” is quite subjective. An outstanding sum of $100,000, for instance, may be too small for a bank to want to refinance; but it may be a staggering amount based on your finances. 

In general, pay off the last remaining amount only if it wouldn’t completely deprive you of savings. 

2. People unable to secure mortgage insurance for any reason

Mortgage insurance pays off the outstanding home loan if a borrower dies or is permanently disabled (some variations may exist between policies, but most work this way). 

Note that, unlike HDB’s Home Protection Scheme, mortgage insurance for private properties is entirely up to the borrower; you’re not obliged to have it, but it’s not automatically there for you either. 

There are rare individuals who may not be insurable, due to factors like pre-existing conditions. If you’re in this situation, and you are the sole breadwinner, it could make sense to pay off the mortgage more aggressively (at the very least, you will leave a smaller debt if anything happens to you). 

Note: We’ve heard that some people will instead cover the mortgage via life insurance. We’re not financial advisors, so we would suggest you check with the professionals if that would work for you. 

However, we would add that – for private properties – it’s possible that the outstanding loan amount cannot sufficiently be covered by life insurance pay-outs (or might devour the entirety of the pay-out). A typical loan for a new launch, mass market condo today, for instance, will generally involve a loan quantum above $1 million. This is quite a sum to cover with life insurance policies, so you may want to make it a point to pay down the loan more aggressively anyway. 

3. Anyone intending to purchase a second property

If you have one outstanding home loan when you purchase a second property, the maximum loan quantum falls to 45 per cent (if the loan tenure for the second property extends past 30 years or the retirement age of 65, the quantum drops to 25 per cent). 

If your plans involve purchasing a second home, you’re almost always advised to discharge the existing loan first. There’s seldom a good reason to lock up so much cash in a large down payment.  

4. Homeowners with debt anxiety

Some people are just uncomfortable with debt, and paying off the loan can ease anxiety. While there’s nothing inherently wrong with this, do ensure that the comfort doesn’t come at the cost of sensible financial planning. 

If you’re completely bereft of savings after paying off your home loan, it’s probably a dangerous thing to even consider; regardless of how at ease you might feel. Speak to a qualified financial planner first. 

A note on prepayment penalties

If you are trying to discharge the home loan early, there may be a penalty involved – this is usually 1.5 per cent of the undisbursed loan amount. However, some loan packages will waive this, or at least limit the maximum penalty – check the terms and conditions before going ahead. 

Also note that the prepayment penalty period is not for the duration of the entire loan – if you’re past this set period, you could repay the loan without penalty. It might be worth waiting a little longer to reach this point, before paying off the loan. 

Finally, for those worried about interest rates, remember these move up and down over time

The US Federal Reserve (the Fed) hikes rates to combat inflation. Once the target inflation rate is reached (currently set at two per cent), the rate hikes will probably stop. 

Also, as we saw with the Global Financial Crisis and Covid-19, the Fed does lower interest rates to act as a stimulus in times of crisis. This means the current state of higher interest rates can’t be assumed to be permanent. A home loan, with its long tenure of around 25 or even 30 years, is likely to see many ups and downs in interest rates over the years. 

We would discourage an episodic point of view, where you overcommit to paying off the loan just because rates are higher right now. Focus on long-term affordability, rather than fluctuations you can’t control. 

This article was first published in Stackedhomes.