3 reasons why choosing a longer loan tenure is a no-brainer - New Gen Home

3 reasons why choosing a longer loan tenure is a no-brainer

Should I minimise my interest expense and pay up my loan obligation as soon as possible? In this article I will take a deep dive and share why I think it is always best to maximise your loan tenure.
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Power of Leverage

If you are considering taking a longer loan tenure, there are a number of factors that you should consider. A shorter loan is typically less expensive, but it also might not fit your budget as well as you need it to. Here are 3 common reasons why people prefer a shorter loan tenure is better. 

  1. Why would I want to waste money on paying interest to the bank when I can avoid it? 
  2. I should always put up a larger down payment and pay up my mortgage obligation as soon as possible. 
  3. Interest expense is bad, debt is worse. I want to eliminate it as soon as possible by repaying my loan in the shortest possible time.

But are interest expense all that bad? Whenever I am asked to give my opinion on loan tenure, my views are always the same. 

Prioritize on home affordability, but take on the maximum loan tenure the bank is willing to offer you.

I need to clarify this, nothing is stopping you from paying down your mortgage early if you want to. The truth is home equity isn’t really going to be making you money. As unpopular as that is to say, when you have your liquidity held up in a property, it’s not money that’s easily accessible to invest elsewhere at a higher return.

You must understand that debt is not the enemy here. Debts are only bad when you are not disciplined enough to manage it. When it comes to mortgage debt. Your focus should be on focusing on the long term appreciation of the property. If you are a real estate investor, taking on a maximum mortgage debt will benefit you in the long run. 

In this article, I will show you why.

I will give you an analysis using one of my landlord’s investment properties as an example. I will break down the sums to illustrate your expected return with a 15 years loan tenure compared to a 30 years loan tenure.

Hopefully, this article will help you see the power of leverage and how it will benefit you in the long run financially.

Case Study - Guillemard Edge

The project is popular with many property investors. The location is also very popular with expats for its vibrant neighbourhood and centralized location.

The attractive rental yield combined with the fact that It is one of the few full-sized condos available with complete amenities makes it attractive to many prospective tenants. The monthly rental rate of his property currently is $1,850.

Property Purchase Price: $488,000
75% Loan Amount: $366,000
20% CPF: $97,600
5% Cash: $24,400

15 years VS 30 years

 15 years loan tenure30 years loan tenure

Loan Amount 

$366,000

$366,000

Downpayment (CPF + Cash)

$122,000

$122,000

Interest Rate

1.3%

1.3%

Monthly Mortgage

$2,239

$1,228

Total Payable Interest Expense

$37,041

$76,193

Total Payable Amount

$525,041

$564,193 

15 years loan tenure

Pros

  • Lower interest expense
  • Debt free in 15 years
  • Higher principal repaid per month means you can build up equity really fast

Cons

  • Monthly repayments are higher
  • Lesser monthly cash flow if you are a landlord
  • Higher monthly repayments means you can borrow less money to buy 2nd real estate because of TDSR limit

30 years loan tenure

Pros

  • Lower monthly payment
  • Improved cash flow every month
  • Lower monthly repayments means you can qualify for larger loan amount for 2nd property

Cons

  • Higher interest expense 
  • Lower principal repaid per month means you build up equity much slower 
  • Takes longer time to be debt free

This is the part you start asking, “Hong Jie? Isn’t it obvious that it doesn’t make any financial sense to take a longer loan tenure?”

Reason 1: Inflation

What most people end up forgetting is the presence of inflation. 

Inflation is a concern when it comes to a mortgage payment. This is because it makes money today less valuable tomorrow. Inflation erodes your purchasing power and can even impact your ability to retire.

When it comes to the mortgage loan, it is the equivalent of me giving you $10 right now and you repaying the $10 in principal and interest every month for 30 years.

Assuming your monthly repayment amount stays the same, your present dollar value is going to be worth a lot less as the days go by. 

So it makes more sense to take up a longer loan tenure and minimise your cash outlay every month. This allows you to profit the difference when your property appreciates in the future. Moreover, you also improve your cash flow position to deal with any unforeseeable financial hardship. 

Reason 2: Opportunity Cost

Another point most buyers don’t remember is the opportunity cost of committing towards a shorter loan tenure. The surplus of cash you used for your mortgage repayment can also be used for other higher-yielding investments. Let’s examine further! 

15 years loan tenure

30 years loan tenure

 

15 years loan tenure

30 years loan tenure

Loan Amount 

$366,000

$366,000

Downpayment (CPF + Cash)

$122,000

$122,000

Interest Rate

1.3%

1.3%

Monthly Mortgage

$2,239

$1,228

Difference 

$2,239 – $1,228 = $1,011 per month

Another point most buyers don’t remember is the opportunity cost of committing towards a shorter loan tenure. The difference in repayment amount for your mortgage repayment can also be used for higher-yielding investments. 

For example, take the S&P 500 ETF index. Investing in an S&P 500 ETF is a popular alternative if you are looking for investment returns that are well diversified with decent returns.

Past 10 years returns of S&P 500

The average return for the last 10 years of the S&P 500 ETF (after including dividends) is 14.4%. After fulfilling his mortgage obligations of $1,228 (30 years tenure). He can use the difference of $1,011 cash to invest in the S&P 500 index ETF funds every month.

In a hypothetical situation, if Mr Chui had bought his house in the year 1991, and the monthly mortgage difference has been invested into the S&P500 ETF in the year 1991, he would have a fully paid home and approximately $2.01M left in his bank account by today.

Suddenly, the interest cost savings for taking up a 15 years loan doesn’t seem to make much financial sense. 

Reason 3: Cash is King!

Let’s face it, there is no doubt that the unprecedented COVID-19 is probably going to leave a lasting impact on the economy. Remember, every dollar put toward your property weaken your cash liquidity. 

Even though you can take up a cash-out equity loan from the bank to unlock the paid-up equity of your property, you need to be mindful that the loan amount is subjected to market conditions and banks’ valuation. Cash-out equity loan also comes with additional conveyancing and administrative charges. The worse part is you can only use cash to repay your cash-out equity loan. 

In times of financial hardship, you would want to improve your cash flow and minimise your cash outlay obligations.

You want to put yourself in a cash liquid position whereby you are lowest risk for default and can better withstand any unforeseeable financial hardship.

This means you can better ride out the property market cycle for a better property appreciation gain.

In addition, the average age of successful en-bloc transactions is between 20 – 30 years (from TOP date). Through lowering of monthly repayment, you minimise the risk having to sell at a loss, you also stand a better chance to participate in en-bloc sales when the opportunity arises! 

Conclusion

The above are all important considerations that you must have when deciding on your loan tenure. Remember there is nothing to stop you from paying off your mortgage early. If becoming debt free sooner makes you feel more comforting, then I highly suggest you go for it. 

Alternatively, if you are find investment in equities too risky for you, early repayment of your mortgage debt can be a good capital preservation method too. 

As a realtor working in a continuously changing economic landscape, it is increasingly important to advise my clients beyond transactions. Every client’s financial situation is unique, there is no one size fits all solution for every case. As a realtor myself, my job goes beyond transactions, it is important to go beyond my duties and assist my clients to seek the best outcome possible for all property-related matters.

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