If you have some extra cash lying around, we tend to use it to pay off house loan early so that we won’t be bogged down with loans well into our retirement. This is because housing loan can now go until 40 years or until we are aged 70.
Isn’t it a good thing then to settle our debts earlier?
Well I’m sure you have heard of the term, bad debt and good debt. Bad debt refers to debt that has a high interest rate, such as credit card and personal loan. It can reach double figures, with credit card interest in the range of 15% to 18% per annum, while personal loan is around the 10% range.
The interest rates are kind of fixed, so if you have extra cash – it is better to clear off your credit card and personal loan. Unless you can find an investment that can give a return which is higher than 18%. And consistently giving out that kind of high returns.
Whereas a good debt is having an interest rate that is low, but appreciates in value. Just like a house is. The current interest rate for loans in Malaysia is 4% to 6%, but your house value could go up by 10%.
If you have bought a house in the 1990’s or 2000’s, the house price have increased several times over.
So here’s a few reasons why you shouldn’t pay off house loan early.
1. Low Interest Rates
Yes, the primary reason is that the interest rate for housing loan is one of the lowest, if not the lowest. Compare that with the double digits that a credit card or personal loan, and you know that you are using loans for a good thing.
You should just enjoy the facility that the banks have given you, and take full advantage of it.
2. Invest For Higher Returns
Let’s say you have extra cash around RM100,000 and are considering to dump it all in your housing loan. But there’s a potential to make 8% return on the investment, which gives you an extra RM8,000.
In this case, you should go for that investment instead and let it compound annually. Using Rule of 72, the RM100,000 would have doubled to RM200,000 after nine years, provided that the 8% return is consistent throughout the years.
You shouldn’t pay off house loan early, if you can find a good investment.
3. Higher Return On Equity
For example, a property worth RM1 million which gets a rental income of RM50,000 a year, is fetching a 5% yield. If you buy the property without a loan, your return rate is 5%. When you get 90% financing from banks, your equity is RM100,000. So your return on equity is 50% (RM50,000/RM100,000).
If your rental yield of 5% plus all future capital appreciation is higher than the mortgage interest, the leverage effect allows you to get a higher return.
As you slowly pay down your outstanding principal, you build up the equity of the property. With a higher stake, your return rate comes down. That’s the reason that the more you pay down your mortgage, the return comes down too due to lower leverage.
4. Extra Payment Not Liquid
The equity value or extra funds that you put in your property is not liquid. You can’t take it out straight away, like you normally would when putting in your savings account. You might need to wait few days or weeks to cash out.
Another way to unlock your property is by refinancing. But this would involve a new loan agreement, legal fees, admin fees etc. And by the time you get the money, it will be a few months later.
That’s why you shouldn’t pay off house loan early, since you can’t take it out easily.
5. Tax Benefit
When you have rental income on a property that still has a loan, you can write off the mortgage interest when filing taxes. So the more you pay off the principal, the less interest you can deduct. Therefore, you might end up with more tax liability.
That’s Why You Should Not Pay Off House Loan Early
Now you understand why you should not pay off house loan early?
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