A comment by Andy from Tacomob in a previous post on HDB loans led to this post. I was sufficiently intrigued to try and dig out my calculations from 5 years ago. Unfortunately, they are nowhere to be found. Heck, so I made new ones! This time, I cheated by using a financial calculator app, though.
Sidetrack a little for now – I saw this post yesterday on buying a first home and the considerations that went into it. In particular, I was interested in this part that goes –
For example, if we had opted for a $300,000 loan over 25 years, the total amount that we would have paid inclusive of our interest would be: $408,300. That means the interest alone would be $108,300! On the other hand, if we had opted for the same loan over 15 years, the total amount that we would have paid would be: $362,700. That’s a difference of $45,600! Madness. Also, that would mean losing out on at least 2.5% interest that we could gain if we left our savings in our CPF accounts!
Uh, but that’s not an apple to apple comparison. If the loan was over 25 years, indeed the total amount of interest paid is more. Simple Maths. But, you would be paying less per month, and the “leftovers” would be sitting in your CPF-OA earning 2.5% 🙂
Still confused? Let’s look at my real-life example.
I Need To Borrow $169,200
$169,200 was the exact amount of HDB loan I needed to get for my apartment after HDB cleaned out our CPF-OA money. So, back in my days, would I have taken a 15-yr HDB loan or 30-yr HDB loan? I found it difficult to decide, which was why I tried to do some simple calculations.
To simplify the calculations, I had to make some really convenient assumptions. For the purpose of my loan, let’s assume a married couple contributes exactly $1,136.19 into their CPF Ordinary Account (OA) every month, over a period of 30 years. No fluctuations at all. No involving of cash at all.
Use $677.37 from CPF-OA every month to repay the loan. This will take exactly 30 years. Concurrently, the remaining $458.82 each month stays deposited in the CPF-OA account that earns 2.5%.
Use all of it ($1,136.19) towards repaying the loan, which would take exactly 15 years since it shortens the duration by 15 years. To make a fair comparison over a 30-year time-frame, the married couple (having cleared the HDB loan) now deposits $1,136.19 into CPF-OA monthly from year #16 to #30.
Woah. We see that the interest savings is close to $40,000 if I choose to shorten the HDB loan from 30-year to 15-year! (Which was also what Andy was referring to) Easy decision, right?
Wait a minute. But I need to consider the overall benefit over the time-frame of 30 years to be fair, isn’t it?
Since any unused CPF-OA money sits inside earning 2.5%, for Option A it is equivalent to contributing $458.82 monthly over 30 years.
For Option B, it is equivalent to contributing $1136.19 monthly over 15 years, from year #16 to year #30.
Where would we stand by the end of year #30?
In both options, my wife and I would have contributed the same amount into our CPF-OA accounts.
I’m not sure if I missed out anything in my calculations (please help me out if I did), but it appears that for my simple example with plenty of assumptions, the net benefit of choosing Option #2 would be $2804.99 🙂
** I did not factor in that the first $20,000 in our CPF-OA account earns 3.5% interest instead of 2.5%
** Edit : Coincidentally, a certain Man of Leisure wrote his take on why he chose a 30 year bank loan over a shorter one.