Of the many daydreams that I’ve had, I often think about paying off my home loan faster. After all, it is the biggest loan that I have and not having to make monthly mortgage repayments would provide me with more cash on hand. It would remove my largest liability and give me peace of mind by removing the psychological cost of debt.
It’s a tempting thought and I have really considered withdrawing large sums of money from my own savings account to do so, but here are my three reasons why I ultimately didn’t, and why you shouldn’t too.
If you live in Singapore, there are two common options that homeowners consider when financing a home — a bank loan or HDB loan (ranging from 1.5% to 2.6% interest p.a.). Though banks may raise their interest rates, historically, it has never gone higher than 4%.
On the other hand, if we look at the annualised average returns of my favourite stock market index – the S&P 500 – it is at a solid 10%! So instead of using your money to reduce your home loan, you can invest in an S&P 500 ETF (or similar) to earn a higher return. In other words, the stock market can essentially help you ‘pay off’ your mortgage over the long term.
Consider two hypothetical homeowners with 30-year loans. Tom steadily increases his mortgage repayments every year and accomplishes his goal of paying off his entire home loan five years early. (Fun fact: there’s a prepayment penalty for paying off your home loan early with the bank; there’s no prepayment penalty for HDB loans.)
On the other hand, Harry maintains his mortgage payments and invests his extra funds in the stock market. He takes a longer time to pay off his home loan. But besides his owning property free and clear at the end, he also owns a stock portfolio that has significantly appreciated in value over the last three decades!
The risk from investing is that the stock market can be volatile over the short term and crashes will happen in certain years. However, stock markets tend to rise over the long term. Therefore, disciplined and steady investment in the stock market over a long period is a must.
Emergency funds are extremely important. It can be used in times of emergencies or unexpected events. By having a reserve fund, you’ll be protected from the need to take a loan with very high interest rates. By accelerating your home loan repayment, you will have less cash (or liquid assets that you can liquidate quickly) in the event of emergencies.
If your wealth is locked up in your home, you’ll find it very difficult to liquidate your wealth when money is needed urgently. Selling a property can take months, and you may be forced to accept a lower sales price if the money is urgently needed.
Inflation drives many things up. Cost of goods and services become more expensive as the value of each dollar decreases over time. On the other hand, this also means that the value of your outstanding home loan decreases over time in dollar terms; paying off $500k 30 years from now is cheaper than paying $500k today. Of course, banks charge you interest on your loan to keep up with inflation. But if inflation is higher than the interest rate you pay, then your loan actually becomes cheaper in real terms.
Another point to consider is the rise of your income over time. From 2016 to 2021, wages in Singapore have risen by 2.1% in real terms. As long as your wages are rising in tandem with inflation, you should be able to keep up with the rising costs and pay off your home loan over time.
Though it’s tempting to pay off your home as soon as possible to achieve freedom from debt, remember that the path to financial independence isn’t a sprint but a marathon. While paying off your debt is good thing, it’s more important to start investing today and grow your wealth in the years and decades to come.