When should you consider a shorter home loan tenure?

If you’re a financially conservative Singaporean who hates to take on debt, chances are you’ll cringe at long home loan tenures. Not only does the concept of borrowing stresses you out, you feel you’re losing out by taking a long tenure.

Truth is, home buyers are often advised to take the longest home loan tenure they can, and it’s not because big banks want to gobble you up and leave you penniless. We’ve written an article about how a stretched-out home loan can actually benefit buyers, and that leaves very few instances where opting for a short tenure makes financial sense.

First, let’s understand the reason why conventional advice is to stretch out your home loan.

Before we even look at the reasons why to consider a shorter loan tenure, let’s consider why conventional advice is not to do it.

When you reduce your maximum loan tenure, your monthly repayments rise by a significant amount. For example, consider a HDB housing loan of S$360,000 over a 25 year period (the maximum possible term). The interest rate on an HDB loan is 2.6% per annum. The monthly loan repayment would come to roughly S$1,600 per month.

Shorten that same loan tenure by just 20 years, and it goes up to S$1,925 per month. Shorten it to 15 years, and it comes to a whopping S$2,400+ per month.

Bear in mind that in day-to-day life, your remaining home loan amount is less important than your cash flow. For example, if you get retrenched and need to take up a lower paying job (even temporarily), the higher monthly repayment means you’re at much greater risk of failing to service the loan.

If S$1,925 is due next month and you don’t have it, who cares whether you only have 15 years or 10 or however many years to go? For most people, the ability to service their mortgage is a more pressing concern than the amount saved on interest repayments. (Before you say it, refinancing isn’t always a viable option).

Also, you have to consider your end-game here. Say you end up paying your flat by age 55, and then you’re retrenched or have some kind of emergency. You have little or no savings, just a paid-up flat. What then? Are you okay to sell to unlock the cash value, there and then?

One compelling reason to take a longer loan tenure, even if you pay a higher interest, is that the interest is fixed at today’s value. In other words, as time goes by and inflation reduces the value of a particular sum of money, the interest you owe the bank gets ever cheaper. Better to take a longer tenure while you take your free cash flow to invest in products that actually keep up with inflation.

Once you’ve understood the above, you can consider the following reasons for a shorter loan tenure:

• You can meet the TDSR / MSR easily, even on a shorter loan tenure
• You have the means to keep substantial savings, even while paying more monthly
• You’re not an owner-occupier, and you’re looking at long term gains
• You fulfill the reasons above and have grand plans for future property investments

Reason #1: You can meet the TDSR / MSR easily, even on a shorter loan tenure

For bank loans, your monthly loan repayment, plus any other outstanding debts, cannot exceed 55% of your monthly income. For loans on HDB or EC purchases, your monthly loan repayment cannot exceed 30% of your monthly income.

As a shorter loan tenure means higher monthly repayments, you need to check whether you can actually qualify. If you don’t meet these requirements, you’ll need to either raise the downpayment, or just buy a smaller house; then you might be able to afford the shorter loan tenure.

Reason #2: You have the means to keep substantial savings, even while paying more monthly

Home owners should save an emergency fund, which can cover at least six months of mortgage payments. If anything goes wrong, this buys you time to find a new income source, find a tenant, sell the house without having to take a big loss, etc.

The emergency fund can either be in your CPF Ordinary Account (you can set aside up to S$20,000 in your CPF when buying a house), or in an accessible savings account. Don’t lock it up in some kind of bond of endowment, where you can’t withdraw it in emergencies.

If you don’t have these savings, approach a qualified finance expert for help before taking a short loan tenure. Their answer is likely to be staring at you as if you’re crazy, but ask anyway.

Reason #3: You’re not an owner-occupier, and you’re looking at long term gains

Investors have more reason to take a short tenure than owner-occupiers. The rationale could be because paying lower interest equates to better rental yields and gains; such as for an investor who intends to hold and sell in 20 years or so.

Some investors may also be keeping an eye on mortgage interest rates, which have been at historic lows for about 10 years. They could save in the long run, by paying off the loan before interest rates rise. For reference, the historical interest rate for home loans in Singapore is close to 4%.

But since 2008, interest rates have been after half that amount or less, and Covid-19 has brought rates to record low levels. A return to the historical rate would make properties far more expensive than expected.

Also, if the property in question is not actually your home but an investment property to be rented out, it’s less of an issue to quickly offload it if you need the cash in short notice. A genuine owner-occupier whose property is a family home is in a tougher position to do so (they sell it off quickly and then live where?)

Reason #4: You fulfill the reasons above and have grand plans for future property investments

If you’re flush with cash, earn a big paycheck, and your friends call you a serial property investor, you’ll want to simplify your future cash flow by taking on short tenures for your property/properties.

A 15-year loan tenure, for instance, automatically clears up your loan obligations by the 15th year, letting you obtain the maximum 75% loan for your next residential property (assuming the loan-to-value ratio rules stay the same) without the hassle and financial penalties of early redemption.

Note that in most cases, early redemption is still the more cost effective option. But if you have five or more property investments, whether it’s in residential or other properties, having long loan tenures might constrain the leverage you can get for your property investments down the road, as you expand your portfolio. Too many mortgages will simply make your head spin, especially when it comes to refinancing.

In any case, you might want to consult a mortgage broker or financial adviser before setting your plan/home loan in stone.

Would you take a shorter home loan tenure? Share your view in the comments below!