By Jennifer Yeap (guest contributor)
Buying a home is probably the biggest financial decision you will make in your life, and one that binds you to a long-term financial commitment. You should thus plan the loan repayment, loan tenure, and other costs associated with owning a new home before you commit to buying a home.
When considering home loan options, many Singaporeans think a shorter loan tenure allows the home owner to pay the loan off faster and, therefore, reduce the amount of interest payments. Many home owners do not wish to be paying their debts till they are 65 or even 75.
How to Decide On Your Home Loan Tenure
Let’s look at a scenario featuring a savvy property owner. Assume a loan amount of SGD1 million at an annual interest rate of 2%, and the home owner can choose from a loan tenure of 30 years, 20 years or 10 years.
Note: A savvy property owner would usually refinance their mortgage every 2 to 3 years.
Here are five ways this helps you as a homeowner or investor:
Benefit #1: Longer loan tenures reduces the monthly repayment
Many home buyers overlook the other monthly costs associated with owning a new home, like fire insurance, mortgage reducing insurance, property taxes, utility bills, and perhaps credit card payments (if they bought furnishings for the new home on credit).
They decide to pay aggressively pay off the loan on a shorter tenure and at much higher monthly payments thinking this would cut the loan payment short and minimize the interest they have to pay. As a result, they may find themselves in a tight monthly cash flow situation.
Benefit #2: Lower monthly repayments provide a cushion against future interest rate increases
While banks offer two types of home loans – fixed rate home loan packages where fixed rates usually apply for an initial period before floating rates apply, and floating or variable home loan packages where interests are tied to a reference interest rate – home buyers should anticipate that spikes in interest rates mean spikes in monthly repayments as well. A longer loan tenure gives you a safety net against interest spikes.
Benefit #3: Lower monthly repayments gives you options when you refinance
Adjusting from a short loan tenure to a longer one may not be easy, if at all possible. Most banks implement a policy whereby borrowers will only be allowed to take over the remaining loan tenure at the point of refinancing (i.e. if your loan tenure is 20 years, in 3 years later you will only be eligible for a 16 year loan regardless of your age). In effect, this has forced you to lower your loan tenure and increase your monthly payment.
Benefit #4: Property investors can use longer loan tenures strategically
If you own multiple properties or plan to buy multiple properties, a longer loan tenure lowers your monthly repayment and could be the determining factor in whether you meet the Total Debt Servicing Ratio (TDSR) requirement for your next purchase.
One final myth to dispel is that a shorter loan tenure significantly reduces the interest you need to pay. People often think the monthly installments for home loans are computed in the same way as a car loan or personal loan. This is not the case.
Home loan monthly installments are based on a loan amount amortized over the loan tenure, and the interest is computed based on diminishing balance each month. Car loans or personal loans charge interest using the flat add-on method.
As the table above demonstrates, the difference in interest payments over a loan tenure of 20 years and 30 years is only $1,458 over 3 years. That’s $486 per year!
Ultimately, decide on a home loan tenure based on this question: What can you afford? Learn how to maneuver the available home loan payment options to best suit your circumstances. All the best!
By guest contributor Jennifer Yeap, Associate Director ofRedbrick Mortgage Advisory, which assists investors and homeowners in sourcing for the best financing option catered for their needs. They partner with major local and international financial institutions and deal with the banks on the consumers’ behalf. The team at Redbrick has handled over 2,000 properties and over SGD$2 billion in mortgages.
Thanks for your illustration on the interest payment comparison for different tenure. I do agree that we should maximise our loan tenure but this should be to a point where one is comfortable. Personally, I don’t think I would stretch mine beyond 65 years old (not that we can now with the cooling measures) as earning power by then would be reduced.