Why one should not fully pay off mortgage for primary residence
Housing loan is one of the loans many people will come to have, one of the mantra in personal finance is to be as debt free as possible but this does not really apply in primary residence housing loan and when you have interest free study loan. While the saying that being debt free is good, it does not really apply to housing loan even though the interest rate on mortgage is definitely higher than the risk free return from savings, fixed deposits and government bonds. We shall see why in this post on the reasons it is not very wise to pay off mortgages for primary residence even if one has the financial capability to do so, it is obvious that loan for properties that are intended for renting out to generate rental income is not to be fully paid off in cash if one is able to.
1. Potential loss of remaining unpaid mortgage value for oneself and next-of-kin if were to become disabled or died
This is perhaps the single largest reason for not paying off housing loan even for primary residence. Most breadwinners will have mortgage insurance for this home to pay off remaining loan in the event of death or total permanent disability. If one has $200 000 cash lying idling in various bank accounts and use for a fully paid out house, then in the event of death, his family only got the fully paid out house while if he instead leave it lying in the banks, his family will have got a fully paid out house (paid off by mortgage insurance) and the $200 000 cash as well in the event of death.
2. Opportunity cost of locking cash in house
In general, the housing loan interest rate is around 3% to 4%, by fully paid out the loan, one can save the 3% to 4% for the next 10 to 30 years, depending on period chosen. However, one will also be cash strapped by the same amount of the next 10 to 30 years, because the amount is going to be substantial, somewhere in the region of $100 000 or more, the opportunity cost will also be great if it is not used to pick up stocks selling in bargain price during stock market crashes. Even if one were to play it safe in the stock market by investing in ETFs tracking indexes, the return will most probably be more than 3% to 4% more than 20 years down the road.
3. A mortgage is the least expensive loan
To give a figure for illustration, it doesn’t make sense to lock $200 000 in house to save 3% to 4% interest rate only to pay 24% interest in credit cards debt when you want to buy something that you like or 7% in car loan when the $200 000 is used to exchange for 100% house equity. The idea is to leverage on the loan with the least interest rate.
4. Invest in a single premium endowment
This is for those who are particularly risk adverse. One of the considerations in purchasing endowment policies despite offering guaranteed yield that is higher than a bank fixed deposit is that given a relatively long period of premiums commitments and economic uncertainty in today’s times, there is a good chance of inability to make payments years down the road. The single premium endowments do away with the risk of inability to pay off the premiums.
In the case of having a windfall of $200 000 (figure used is for example) or $200 000 savings from a high income and bonus job, one will still do better to invest in a single premium endowment for around the same loan period and interest rate as mortgage, than to use the same $200 000 for a fully paid out house, as this not only offset the interest rate from housing loan but also provide additional death and total permanent disability benefits.
There may be a penalty for surrendering before a certain date, but if did not surrender, $200 000 inside an endowment policy can earn compound interest with the final amount be substantial 20 years down the road than if were to lock inside the house, since the $200 000 will not increase in value and the market price of house will continue to rise regardless of whether the house is 20% equity/80% mortgage, or 100% equity.
5. Net Worth remain the same if paid off the housing loan
Net worth of an individual is calculated by total assets minus total liabilities of that person. If $200 000 cash is shifted into $200 000 house equity, the net result is the same as $200 000 cash in banks and $200 000 in mortgages. The only difference being that of having your $200 000 cash frozen inside housing equity.
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