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.

**Option A**

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%.

**Option B**

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.*

Max says

Hi Kevin, I may be wrong, but I think as long as the HDB loan interest (currently at 2.6%) is higher than the CPF OA interest rate (2.5%), it will be better to repay the HDB loan asap.

This is analogous to the decision on whether to return debt or invest your savings. We will usually tackle the one with higher rate first.

However, the computation is complicated with the additional 1% on the first 20k of CPF OA savings. In the scenario you depicted, it will be better to go with plan A, which will generate about $10-15k* more interest after 30 years form the additional 1%. But this is assuming the couple only generate exactly $1,136 in CPF OA every month to repay the monthly loan, with zero leftover in the CPF OA account to earn the additional 1%, which again is not a likely scenario.

*as ref, a $20k transfer from OA to SA (1.5% more) will earn about $25k extra interest in 30 years

Mafia

Kevin L. says

Hi Max,

Thanks for sharing your thoughts! Yeah, had to make plenty of assumptions to make the comparison a simple one. What you said is true, regarding zero leftover in the CPF OA which is why I omitted it in my calculations.

The point I wanted to make is that in my sample scenario, a 30-year HDB loan is obviously “worst off” (more interest paid) than a HDB 15-year loan. But, by how much? Is it $40k or $2k?

Although we are “worst off” at first glance, what benefits do we have from doing it? We could do transfer from OA to SA and game the system. We could invest and get returns that is > 2.6%. And then, there are intangible factors that we cannot measure in monetary terms.

Max says

I see. Indeed, the benefits of a shorter HDB loan is not that significant as I thought it would be.

Cheers

Max

Raymond Koh says

Have done a study somewhat like yours before, taking into account 3.5% on first $20,000.

https://docs.google.com/spreadsheets/d/1MKNCb9I1pLCsXtfHebMypgbbwDN1K5jPFiV1Mkexuq4

Kevin L. says

Thanks Raymond! You’re much more hardworking and hands-on than myself. I used your spreadsheet and punched in my numbers. I’m guessing we came to similar conclusion 😉

Frugal Daddy says

Hi Kevin

2 things. 1St, hdb 2.5% interest is based on lowest balance each month and pay out yearly which doesn’t compound monthly. Hence it is lesser. Try computing your cpf interestm.

2nd, there is a marginal saving on your house insurance when u cleared up mortgage earlier.

Easy, option 2, after 15 years, do you have more cpf balance to clear the mortgage 1 shot if u choose to? If not, then the obvious answer is to choose 15 years’.

🙂 Frugal Daddy

Kevin L. says

Hey FD!

1) Thanks for pointing out my mistake on the CPF interest rate computation. I had used a standard financial calculator which didn’t factor this point.

2) Ah, the Home Protection Scheme. Got it.

The outcome (I used Raymond’s spreadsheet) was similar – in pure monetary terms, the decision will always be easy, Option #2 (shorter loan) is always a better deal.

Raymond Koh says

Another advantage of longer loan is lesser accrued interest to repay back if you sell your house. Think this is the most important reason for me. Forgo a few hundreds/low thousand to have less accrued interest (which will be a lot if you pay off very early on!) even though I might never sell the house to reap the benefits.

Kevin L. says

Thanks for this great share!

This was something that I realized very late, probably into my 2nd or 3rd year, when my friends are complaining about the snowballing accrued interest and I wasn’t too sure what the big fuss was about. Because a large chunk of my CPF-OA money is just sitting there earning interest like it was intended to be, whereas a very aggressive repayment strategy leaves very little remaining CPF-OA money.

Max Lim says

I took 30 yrs loan but push OA to SA …

Kevin L. says

Hi Max,

Thanks for sharing your approach. I think we have similar train of thoughts not mentioned in this post. If we can borrow from HDB @ 2.6% and get returns (in your instance, your pick is CPF-SA) that is higher, that we can “game” the system.

FC says

hi K,

not sure if this complicates things even more.. how about using both HDB loan + bank loan?

first, use HDB loan with the longest tenure possible.. save for a X years.. then lump sum repayment after X years. (no penalty for HBD capital repayment, unlike bank loans)

once you have stability, switch and refinance to bank loan (with the min loan amount, either fixed or floating)

the idea is to switch from 2.6% IR to 1.X% IR, after the capital repayment.

of coz its hypothetical and also dependent on individual situations.

i havent work out my sums, just thinking out loud. not sure if it will save substantially.

Kevin L. says

Hi FC,

That would certainly complicate things! To be honest, I’m not very sure how a bank loan would work in this case, and most importantly we’re assuming a low interest rate environment (what we’ve had in recent years) will continue to be available., which I’m skeptical about.

Tacomob says

Hi Kevin,

As usual I am late to the party due to my self-imposed “internet abstinence” over the last few days.

You are right, my initial comment to your previous posts was totally neglecting the interest earned on that balance CPF.

My mind was too much focused on how we do it in eg Germany where due to the absence of CPF we earn no interest on the “leftovers”. Or even worse some people are then tempted to spend that balance on stuff to “save it” from idling in a zero-interest bank account. Sadly hardly anyone in Germany uses the “leftovers” to invest them (the stock investing culture in Germany is so miserable with only about 15% doing it).

By the way, great to see your post triggering so many reactions / reflections.

Kevin L. says

Hi Andy,

What’s with the abstinence?!

No worries, I’m happy to share my thoughts because I know many people don’t even think about this aspect when deciding between a shorter, or longer loan. HDB is really smart in using 0.1% of a difference to nudge people towards the “correct” choice.

Wow, I didn’t know the tendency to invest in Germany is so low. I would have assumed otherwise, in fact.

a says

hi , can i ask how do you compute the total interest earned?

Kevin L. says

Hi, I use interest earned in CPF-OA minus interest incurred from HDB loan. If you are referring to the tool used, I used fncalculator.com Android app.

Richard Tan says

Interesting. I was always of the notion of taking a longer term loan whenever it comes to housing, as the interest rates are pretty low. So we can take advantage of any cash flow we have to invest and get higher returns elsewhere.

Also, we may sell the property before the loan tenure, so how would that factor into things? =)

Kevin L. says

People tend to focus on “pure savings” and neglect considering other factors e.g. cash-flow like you mentioned.

Could be a mentality issue – the idea of being debt-free may be appealing to many!