It is a well-known fact that interest rates are historically low. After the Global Financial Crisis in 2007 and 2008, governments across the world have been trying to stimulate their economies. The main method of doing so is by encouraging spending. The simple way to look at it was that they pushed down interest rates so low that the cost of borrowing would be exceptionally cheap. This would encourage people to spend more. In Singapore, our home mortgage rates have been in the 1-2% range for almost a decade. Thus, current low-interest rates have created a scenario whereby the old thinking of being mortgage free is outdated. The previous generations worked on the mantra of aiming to be clear of any mortgage. Now the idea seems to be that of stretching your mortgage to spread out the payments. While this may seem counterintuitive to leading a debt free life, there are some benefits to holding on to a mortgage.
1) Mortgage rates are probably not going to return to historical highs
We need to understand where the ideology of paying off mortgages came from. In the 70s and 80s, we see mortgage rates at about 10% or in some cases much more. In the US, rates were as high as 15-20%. This meant that a large portion of the monthly repayments was going towards paying the interest portion of the mortgage and little were used to pay off the actual principle. Coupled with the fact that a lot of these homeowners lived through the Great Depression in the 1930s, they viewed home ownership as paying off their home. Fast forward to today and we determine home ownership differently. The current generation views a home as an investment on top of it just providing shelter. Mortgage rates are extremely low. In many instances, they are hovering around 1%. Interest rates do not swing wildly as before and governments across the world are aware of the economic repercussions of a sharp spike in interest rates. Imagine a 20-year mortgage taken in 2008/ 2009 at historically low rates. The mortgage would have already gone through almost half of its tenure at extremely low rates (in fact lesser than HDB loan rate of 2.6%). Back then there were many who were advocating that such low rates were unsustainable past the short run, however for such 20-year mortgages, these rates existed through almost half of their tenures.
2) You may not hold your house for the full duration of the mortgage
If you are looking at your property as a form of investment. A mortgage would help you increase your return on equity. Let’s look at two scenarios.
First scenario. Paying a $1 million property in full and selling it after 5 years
Purchase Price: $1,000,000
Equity (Cash) used: $1,000,000
Selling Price after 5 years: $1,200,000
Return On Equity (ROI): 20%
Second scenario. Taking an 80% loan on a $1 million property and selling it after 5 years
Purchase Price: $1,000,000
Equity (Cash) used: $200,000
Total equity (Cash) for instalments (Estimated): $150,000
Total equity used: $350,000
Selling Price after 5 years: $1,200,000
Return On Equity (ROI): 57%
A low-interest mortgage would reduce the instalments and thus further increase the ROI of your property investment.
3) Maintain Investable Liquidity
There is opportunity cost to paying off your mortgage. If you are paying 1-2% on your mortgage and you pay it off with the cash you have rather than use that cash to invest in other things that presumably can return 5-6% per annum, then the difference is your opportunity cost. Even though opportunity cost is essentially an economic term, everyone who is thinking of investing should understand its importance. A mortgage is most probably one of the most inexpensive loans you will ever undertake. Yet many individuals aim to be mortgage free before clearing their other loans. Other loans like car loans, study loans, credit card debt are way more damaging on an individual’s goal towards financial freedom. It is important to list out your loans in terms of their cost before deciding on which to clear first. Most often than not, mortgage loans should be cleared last.
In conclusion, the ideology of buying a home and paying off your mortgage as soon as possible is an extremely outdated concept. Housing loans are one of the cheapest loans and even if interest rates do rise, they should not be returning to the days when rates were double digits. That being said, it would be wise to always discuss with your bank or mortgage broker the possibility of early repayment or partial pre payments on your existing mortgage. Also, there is always an opportunity to refinance your mortgage out of the lock in period to enjoy promotional interest rates for the initial years.
