Hammerhead is a shrewd licensed moneylender and he owns two separate companies to give the illusion of competition to the general public and consumers.
Hammerhead went ahead and set up two different companies called McShark and Shark King.
- McShark is offering a flat 2.5% rate on all loan amounts with a special condition.
- Shark King is offering a flat 2.6% rate on all loan amounts.
Being more expensive, Shark King should ideally funnel prospective customers to McShark since it costs 0.1% more to get a loan from Shark King.
Hammerhead is a businessman after all and a very good one at that. In the fine print of McShark’s contract, it is stated that the first $20,000 loan amount would always attract a 3.5% interest (additional 1%) which is effectively a two-tier structure.
Poor Boy and Smart Girl are getting married and buying a house. Assuming that Poor Boy wants to get a huge loan of $200,000 to buy an apartment, should he go to McShark or Shark King for a better deal?
Poor Boy is not well educated and very bad with numbers. Therefore, he doesn’t bother to check the contract.
Smart Girl decided to calculate how much difference does 0.1% make for a sum of $200,000. After scribbling on a napkin, Smart Girl showed this to Poor Boy.
$200,000 x 0.1% = $200,000 x 0.001 = $200
“OK, that’s not that bad. I was expecting more.” Poor Boy thought. “Let me try calculating with a small amount instead. I think I can work with that.”
Scenario #1 : Taking a $10,000 loan
$10,000 x 3.5% = $350
- Shark King
$10,000 x 2.6% = $260
Poor Boy: “Wow. That’s a big $90 difference”.
Scenario #2 : Taking a $20,000 loan
$20,000 x 3.5% = $700
- Shark King
$20,000 x 2.6% = $520
Poor Boy: “I see. The first $20,000 with 3.5% meant that McShark’s loan was more expensive by $180! Most people would start by borrowing smaller amounts and they’re all going to get a bad deal by McShark! Let’s try $30,000 too.”
Scenario #3 : Taking a $30,000 loan
$30,000 : = $20,000 x 3.5% + $10,000 x 2.5% = $950
- Shark King
$30,000 x 2.6% = $780
Poor Boy: “Hmm. The difference is now $170 – which is $10 less. So, for each subsequent $10,000 that I borrow, it seems that it created a $10 difference. So that means ..”
Scenario #4 : Taking a $200,000 loan
$200,000 x 3.5% = $20,000 x 3.5% + $180,000 x 2.5% = $5200
- Shark King
$200,000 x 2.6% = $5200
“Hey! There’s no difference!” Poor Boy exclaimed. “That’s crazy! I didn’t know it would take another $180,000 for the Sharkie No. 2 to catch up with McShark!”
What are McShark and Shark King referring to?
If the interest rate numbers look familiar, yes – I had modeled the short story in a way that McShark was referring to CPF Ordinary Account and Shark King was referring to HDB Loan.
- McShark – CPF Ordinary Account (2.5%)
- Shark King – HDB Loan (2.6%)
To me, it felt that having the HDB Loan’s interest being pegged at 2.6% was meant to create a psychological effect by making it seem like a worst-off deal by not repaying your HDB loan. Plus the fact that quite a number of people are averse to having debt meant that it probably worked out pretty well for the relevant authorities.
First $60,000 of combined CPF balances earn additional 1% interest
Although the infographic above is helpful, the shortcoming is that people wouldn’t be able to find detailed information anywhere on how the additional interest is applied, to which accounts, and in what priority sequence.
What I had managed to find out (credit to Wilfred Ling) was that the amount of money that make up that $60,000 (and $30,000) are from the following accounts in order of priority:
- CPF Retirement Account (CPF-RA) balance inclusive of the premium for CPF Life. If you are under 55, you do not have this account.
- CPF Ordinary Account (CPF-OA) balance(but capped at $20,000.
- CPF Special Account (CPF-SA) balance.
- CPF Medisave Account (CPF-MA) balance.
Back in 2017, I wrote about why I took a maximum loan duration of 30 years and used a simple loan calculator to illustrate the difference.
One important to note is that the extra interest, even if it came from CPF-OA, gets credited into CPF-SA and not CPF-OA.
Disregarding the possibility of bank loans which are expected to have low interest rate for the next few years, in a hypothetical situation whereby the only available option is HDB Loan, keeping the first $20,000 in your CPF-OA might be a good idea if you can afford it.
There are also other benefits to keeping money in CPF-OA. One example is that if I happen to die early, my wife would not be burdened by my proportion of loan instalments via Home Protection Scheme (HPS).
Computation of monthly interest – HDB Loan
To complicate things a little bit, the different ways to which the interest is computed adds to the confusion.
For HDB loan, interest is payable from the date your HDB loan is issued. The monthly interest is based on the outstanding loan balance at the beginning of every month.
Monthly interest payable = Outstanding loan balance as at the 1st of the month x R/12 (where R is interest rate 2.6%)
Computation of monthly interest – CPF
For CPF Ordinary Account, CPF interest is computed monthly, then credited to your respective accounts and compounded annually. CPF interest earned in the year will be credited to your CPF accounts by 1 January of the following year.
What does this mean?
As with all things that are finance-related, it isn’t always about good or bad, right or wrong. The purpose of writing is to share different perspectives such that we all can make the best decisions given our own situation.
A debt-averse individual would definitely choose to pay off all loans as soon as possible for peace of mind. It would be the best decision for him or her.
On the other hand, I’m happy to live with my 30-year HDB Loan which still has many more years to go, even when I could have repaid it fully today if I choose to.
This is financial literacy – understanding and applying the knowledge we learnt.
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Hello! I’m Kevin, Turtle Investor
At the age of 30, I am the Personal Finance Blogger who laid claim to a negative net worth of minus $25,755 – and decided to turn things around.
- Seven years later in 2019, I hit CPF Full Retirement Sum (FRS) of $176,000 without making a single cent of CPF top-up
- In eight years, I added $453,000 to my net worth (excluding the value of my HDB apartment)
- I earned over $175,000 in alternative income in 2021 in addition to my full-time job
I am married to a lovely wife and that means dual income with no kids. In my free time, I chase miles so that we can fly in business class. My hobby is making pocket change off this blog and sharing everything I know with you!