A couple of years ago, I was deliberating between paying off the mortgage of the property I was residing in, vs refinancing the mortgage and investing the money in higher yielding assets.
I shared my intention to pay off the mortgage completely with a few of my friends and they were all wondering am I crazy to even consider the idea of repaying the mortgage early. Isn't it better to hold the mortgage at its current low interest rate of ~2% and invest the cash instead? Surely it's not that difficult to find yields higher than 2%?
Coming from a finance background, I totally understood their rationale. Treating it as a pure academic exercise, there is no single reason to pay down the mortgage early. Assuming a $1 million outstanding mortgage with 20 years tenure remaining and a 2% mortgage rate, and simply investing the cash in a 20-year bond of 4% yield, I would be able to pay off the mortgage at the end of 20 years and an additional $367,450 sitting in the bank!
However, the exercise above factors in a few assumptions:
- The mortgage rate doesn't fluctuate and move up above the investment yield
- The investment yield has no risks
- The investment yield is fixed
In Singapore, we don't have a long-term fixed rate mortgage plan. The closest to it is probably a mortgage loan from HDB which is pegged at 0.1% above the prevailing CPF Ordinary Account (OA) interest rate which has been kept constant at 2.5% since July 1999. Hence the best fixed-rate mortgage one could possible get is the HDB loan at 2.6%. The current Singapore 20-year government bond yield is around 2.9%, hence we get a positive spread of 0.3%. However, keep in mind that the 20-year yield has been hovering between 2% to 3% for the past few years so there's no guarantee of a positive spread! In addition, if the CPF OA interest rate (being the higher of the current legislated minimum interest rate of 2.5% of the 3-month average of major local banks' deposit interest rates) was to rise, that could possibly shrink the arbitrage spread as well.
As shown, there is no perfect hedge of keeping the mortgage and investing the cash and earning the assumed positive spread. No matter how unlikely or how low the risk is, there is still risk ultimately.
On the other hand, paying off the mortgage early completely eliminates this risk, and reduces stress. Being completely debt-free means a lot to a retired guy. It means that there will never be creditors showing up at my doorstep, trying to repossess my house. Trying to service a mortgage and investing the money instead is a different ball game which could bring about more stress.You have to strive to beat your cost of the mortgage, even if you may think the benchmark is not set high. Paying down the mortgage early comes at the expense of having less capital to invest and hence lower investment gains, but it gives me financial peace of mind, which I think is a priceless asset in itself.
In the end, I repaid the mortgage and became completely debt-free. I did give up the opportunity to utilize the cash for a potential return, but that is probably a small price to pay for complete peace of mind. Especially now that global interest rates are rising, I do not have to fret. Of course, this doesn't mean that you should be left with no savings or investments after paying off the mortgage!
No comments:
Post a Comment