Owning a house is a wonderful time in life but it will turns into nightmare for most of us when it comes to loan repayment.
Without surprise, the huge mortgage loan will looming over us for decades, that’s the reason why we want to pay it off as soon as we can, but is this the best financial decision to you?
Here are things you should know before you decide to pay off your home loan earlier:-
Ways to pay off your loan earlier
Settle your mortgage loan earlier means lesser interest you pay. Here are some examples where you can pay off your loan earlier:-
1: Rounding up loan payment
Round up your regular loan repayment to nearest RM50 or RM100 not only will makes personal finance management much easier, but also directly save you money.
For example, the monthly installment for a 30 years mortgage loan of RM450,000 at interest of 4.3%p.a. is RM2,226.92. If you decided to round the payment up to the nearest hundred dollar increment, you will submit a payment of RM2300 each month – an overpayment of RM73.08. At the end, you will settle your loan 1 year and 10 months earlier and total interest saving of RM25,190.94.
2: Making partial capital repayment with extra cash
If you have extra cash on hand in addition to monthly salary, such as bonus, tax refund, spending cashback or saving over months and you decided to put away these cash and pay down your mortgage, here are the examples of how much you could save over time if you make an extra RM5,000 payment every year.
Why you should not prepay your mortgage
Prepay mortgage could save you a lot of interest in long term, however, it may not be the best financial decision for you under certain situations:-
1. If you have a short term higher interest debts
Generally, most of the mortgage loan are relatively low interest, if you have other debts with higher interest rate, such as credit card debt and personal loan which may up to 18% p.a., it will make no sense if you use the cash on hand to prepay mortgage loan.
2. If the bank charges you for prepayment
Some of the banks will impose a penalty charge if you settle your mortgage before the “lock in period”, which usually on early stage of the mortgage tenure. But even if your lock-in period expired, you might still be charged for making a prepayment, depending on the mortgage term you signed.
As semi-flexi loan is the default loan type offered by most banks in Malaysia today, it allows you to pay off your loan in advance but there may be a processing fee for withdrawing this additional sums paid and subject to approval from bank.
3. If prepay depletes your cash on hand
House is an illiquidity asset which hard to turn into cash, if prepay your mortgage loan means used up all of your cash, then it will be a bad financial decision as you will be unable to deal with unexpected financial challenges, such as a loss of income or medical emergency.
Pay off Mortgage vs Investment
Lastly, we have to consider between paying off mortgage loan or invest the money instead. As most of the Malaysian’s housing loan interest rate ranging from 4.2%~4.6%, it will makes more sense if you invest your extra money into investments with return of average 6% every year.
Here are some scenarios for you to compare:-
1. Making small amount monthly prepayment
|Tenure||30 Years||30 Years|
|Result||Overpaying RM200 would save you RM60,926 of interest and paying off mortgage 4 Years & 6 Months earlier||Investing RM200 monthly for 30 years with an average 6% return p.a. will grow to RM195,851 (RM72,000 principal + RM123,851 interest)|
2. Making annual small amount principal prepayment
|Tenure||30 Years||30 Years|
|Result||Overpaying RM5000 would save you RM102,398 of interest and paying off mortgage 7 Years & 11 Months earlier||Investing RM5000 each year for 30 years with an average 6% return p.a. will grow to RM432,275 (RM150,000 principal + RM282,275 interest)|
3. Shorter loan tenure
|25 Years Loan Tenure||30 Years Loan Tenure|
|Monthly Installment||RM 2,450.44||RM 2,226.92|
|Result||25 Years tenure will saved you RM66,559 of interest compare to 30 years tenure||If you invested RM223.52 for 25 years with 6% pa, it will grow to RM151,900 (Principal Rm67,056 + Interest RM84,844)|
From the scenario above, investing will offer more financial return compare to pay off your mortgage loan earlier. So instead of paying off your loan earlier, you may consider to make contributions to your Employees Provident Fund (EPF), Amanah Saham (ASB) or other funds which offer you an average 6% return per year.
However, to enjoy the return of investment as above, self-discipline is required to make contribution constantly and you are comfortable with putting your money in low to moderate risk investment for a long time.
As conclusion, to decided whether you want to settle your loan early or not, you have to understand your financial status first, then only choose whichever you feel comfortable with.