Posted: 12 Jan 2009 09:58 PM CST

This article “HDB home loan defaults on the rise” raises the statistic that 1 in 12 or about 8% of HDB owners were in arrears for more than 3 months. In theory, if you just default on a single mortgage payment, your home can be repossessed by the HDB or commercial banks. In reality, both banks and the HDB would not want to unnecessarily repossess the home if the borrower is able to come with with alternatives such as taking a longer loan period or renegotiating the terms of the loan.

What this sobering statistics show us is that there are about 8% of people here who will never be financially free. They are not even current in their home mortgage payments which is for the roof over their heads.

If these people are in such dire straits, what about those who can continue to service their mortgages but will likely end up asset rich, i.e. fully-paid home by the time they retire but have little in their retirement savings?

Why pay off housing loans early?

Given the uncertain economic outlook and the risk of more retrenchments ahead, the strategy of paying off your home loan early can work in some cases. The underlying assumptions of paying off your loan early, i.e. way before the loan period of 25-30 years works in the following manner. In the earlier years of your career, i.e. when you are in your 20s up to late 30s or early 40s, the risk of retrenchment increases with age. Thus, if you can channel more of your available savings in addition to your CPF ordinary account monies into paying off your loan when you are younger, you become less worried about retrenchments when you reach your late 30s or early 40s.

To do this requires a degree of sacrifice and self-discipline. Every dollar that goes into paying off the home earlier is a dollar less to spend on a Starbucks coffee, a new handphone, a nice bag, a meal at a restaurant. Less consumption for now but less liability in the future.

Not everyone believes in such an approach. Some people feel that they should pay the minimum since the HDB loan rate is at 2.6% per annum. So they should borrow at “low” cost and stretch out the repayment. Whilst that is true, the issue is in using the freed up cash to invest at consistently higher than 2.6% p.a. returns. In addition, the amount you borrow for housing in the early years of having your own home tends to be more than what you have available cash for investments. As a result, the amount of interest paid to HDB is still higher than the additional investment returns you can get (assuming you can beat 2.6% consistently without risking your investment capital!)

Others believe that should anything happen, the home protection scheme covering their outstanding HDB loans would give their beneficiaries a “free” HDB flat should anything happen to them. Thus, they prefer to stretch their loans because should they suffer an untimely demise, their spouses get a “free” flat!

Asset Poor Cash Rich?

A relative of mine who is retired has not paid off her housing loan. I was amazed that people would use their annuities to fund their HDB mortgage payments even when their primary means of earned income has stopped. Didn’t they realise that their annuity income was meant for living expenses? This is worsened by the fact that the HDB apartment is already a 3-room flat. There are not much options to further downgrade to monetise the proceeds from selling a bigger HDB to downgrade to a smaller one.

The more I read about the housing situation, the more I am concerned that the ranks of those who are financially unfree grows. The saying the rich get richer and the poor get poorer has never rung more true in recent times. How will your own situation change even as home values get moderated downwards as jobs become less secure and home equity values decline with reduced demand for the next year or so?

Do you think you should pay off your home loan early?

Share with Panzer in the comments section.

Be well and prosper.

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