If you are new to the property lingo, mortgage refers to a loan for buying a house.
Homebuyers usually take a mortgage when they do not have the means yet to buy upfront with cash. And even if they do, they feel that buying the house upfront seems like a lost opportunity cost.
Conventionally, homebuyers would stretch their loan as long as possible. This is because they feel that the monthly housing instalments are more “affordable” as the instalments are lesser.
I usually recommend home buyers to buy their home upfront. However, that would mean a lot of people having to live paycheck-by-paycheck.
Current regulation allows homebuyers to take up to a 35-year mortgage.
While the monthly instalments are cheaper for the longer mortgage, there are many benefits to a 15-year mortgage.
Let’s look at them:
- More savings in total interest paid
- More favourable interest rate
- Not be tied down too long
Savings in total interest paid
Let’s go straight to the point and look at the numbers. We will use HDB loan interest rate (2.6%) and a couple taking $400,000 loan as an example.
For a 15-year loan, the couple would need to pay $2686 every month to service their housing instalment. At the end of the 15 years, they would have made a total payment of $483,480.
For a 30-year loan, the couple would need to pay $1601 every month to service their housing instalment. At the end of 30 years, they would have made a total payment of $576,360.
That is more than $90,000 in extra payments!
This assumption assumes that you are paying your instalments by cash. Imagine if you are paying by CPF. How much accrued interest would have accumulated if you took a 30-year loan?
Build equity faster with lesser interest rate
In the first few years, the mortgage interest makes up the bulk of your monthly instalments. Eventually, some parts of the monthly payments will go toward the mortgage, which makes up your equity, and is also your net worth.
Having a shorter term means that you will be paying more monthly. And it also means that you will be increasing your net worth faster.
Also, a 15-year loan has a more favourable interest rate. This makes it easier for you to build your equity than taking a 30-year loan.
Not be tied down too long
By committing oneself to a 30-year loan, it means that you will have to find ways to pay the loan for 30 years. You may have to be tied down to the same job that you hate so much but can’t quit because you have to service your loan.
Even if you are doing what you love, I believe everyone should have the freedom of choice.
Having a debt is a commitment that might restrict you from doing something that you truly want to do.
Shorter vs longer loan tenure
In the long run, a 15-year loan can be better than a longer-term loan.
To manage the monthly repayments, you have to avoid buying a property that is beyond you.
Having said that, taking a longer-term loan also has its merits. Ultimately you should have a plan first when taking a loan and be strategic about it.
Your affordability is not based on the regulatory benchmark, but your own.
Use my Affordability Calculator to see whether can achieve the house of your dreams.
Feel free to contact me, Andik Imran, for any housing related enquires.