Buying a home is most probably the biggest financial decision you would make; it is also one that would bind you to a long-term financial commitment. Paramount to your success in repaying a home loan is planning for the loan repayment, loan tenure, and the other costs associated with owning a new home before you even look for a home to buy.
When considering home loan options, many Singaporeans mull over the matter on loan tenure. Many share the perception that a shorter loan tenure allows the home owner to pay the loan off faster and, therefore, cut the interest payments short. Quite on the contrary, many think that a longer loan tenure stretches the loan payment and, therefore, extends the interest payment for many years more.
Not only is loan tenure a factor in deciding on a home loan product, many home owners also do not want to pay their debts until they are 75 or 65, even if banks usually grant a loan tenure for up to 30 to 35 years.
How To Decide On Your Home Loan Tenure
To get the best answer on whether or not paying your home loan faster helps you pay lesser interest, let’s inspect the scenario below, featuring a savvy property owner:
Let’s suppose the loan amount is SGD 1M for an interest rate per annum of 2%. 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.
As the above table demonstrates, the longer loan tenure eases the payment of your home loan. These are 5 reasons how this helps you as a homeowner or investor:
1) Longer loan tenures make the loan lighter to pay monthly. Many home buyers tend to 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 aggressively decide to pay the loan on a shorter loan tenure and at a much steeper monthly payments thinking that this would cut the loan payment short and get rid of interests. As a result, they find themselves in a very tight monthly cash flow situation.
2) Longer loan tenures will better prepare you for future interest rates increase. Due to the long-term nature of the home loan, it is wise to anticipate interest rate fluctuations, which may happen throughout the loan tenure. 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 directly mean spikes in monthly payment as well. A longer loan tenure gives you a safety net against interest spikes.
3) Longer loan tenures help keep your options open. While you may have a good reason to want to pay off your debt as soon as you can, adjusting from a short loan tenure towards a longer loan tenure later 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 a point of refinancing (i.e. Today you may be eligible for 20 years loan tenure, 3 years later you would only be eligible for 16 years regardless of your age). In effect, this has forced you to lower your loan tenure and increase your monthly payment.
4) So does a shorter loan tenure help you pay lesser interest? That impression needs to be validated.
People often think monthly installment for home loans are computed 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 interest is computed based on diminishing balance each month.
Car loans or personal loans charge interest using the flat add-on method. This means loan amount x interest rate x number of months for the loan tenure = monthly installment.
As the table above demonstrated, paying the loan for 20 years and 30 years yields a difference of only $1458 for 3 years. That’s $486 per year!
5) Longer loan tenures will be strategic for property investors. If you own multiple properties or plan to buy multiple properties, a longer loan tenure sets your monthly payment commitment and helps you pass the Total Debt Servicing Ration (TDSR) for your next purchase.
Ultimately, it would be best to decide on a home loan tenure based on this question: What can you afford?
Having your own home does not need to be a bane if you know how to maneuver available home loan payment options to work best with your circumstances. All the best!
Article by Jennifer Yeap, Associate Director, Redbrick Mortgage Advisory