Should you pay off your home loan early? Here’s how & when you should do it

When you have something as large as your mortgage loan looming over you, you may be tempted to pay it off as soon as you can. But this isn’t always the best financial decision – here’s what you should know before you settle your home loan early.

house-loan-interest

© Getty Images

An early payoff is a great idea if you want to save on interest payments – The faster you pay off the home loan, the less interest you pay down the road. Just paying it off a few years earlier could give you tens of thousands of ringgit in cash savings!

How to pay my off mortgage early?

Here are a few ways you can pay off your home loan early:

1. Refinancing to a shorter-term home loan

Refinancing means replacing your existing home loan with a new home loan (from the same bank, or a different one). When you refinance, you can switch to another home financing product with a shorter loan tenure. Here’s how different loan tenures affect your interest payments:

© iMoney

A shorter loan tenure means paying substantially less interest. The difference between a 20-year tenure and a 25-year tenure in the scenario above, for example, is almost RM100,000 in interest payments!

But before you spring for a shorter tenure, you will need to make sure that you can cope with the higher monthly payments that come with it:

Monthly instalment for a RM600,000 home loan at 4.5% interest rate per annum

LOAN TENURE MONTHLY INSTALMENT (RM)
10 years RM6,218
15 years RM4,590
20 years RM3,796
25 years RM3,335
30 years RM3,040
35 years RM2,840

READ: What is home loan refinancing & how can I do it?

2. Making small, additional payments every year

What if you put away extra money – such as your bonus – every year to pay down your mortgage? Over time, you could be saving thousands of ringgit in interest and pay off the loan years earlier. Here is an example of how much you could save if you made an extra RM5,000 cash payment every year on your home financing product:

Note: The Overpayment calculator was used for these calculations. © iMoney 

3. Making a large capital repayment towards the principal

If you’ve amassed a large amount of savings and would like to put it towards paying off your mortgage, you’d be paying a lot less interest down the line. For example, here’s how much less interest you might be paying if you made a one-time payment of RM100,000 in the fifth year of your home loan tenure:

Note: The Overpayment calculator was used for these calculations. © iMoney 

Is it smart to pay off my mortgage early?

Although having to pay less interest on your home loan is a compelling prospect, here are a few situations in which you should refrain from doing so:

1. If it depletes your savings

You should not rush to pay off your home loan if that means using all your savings. Your home is an illiquid asset – which means it’s hard to turn it into cash when you need it. If you’ve used all your cash on your home, it could be hard to deal with unexpected financial challenges, such as a loss of income or a medical emergency.

Instead of using all your savings to pay off your home loan, make sure you have an emergency fund in place. This should cover around six months of living expenses.

2. If you have higher-interest debts

Mortgage interest rates are relatively low. If you have other debts with higher interest rates – such as credit card debt – it makes more sense to pay them off first.

3. If your bank imposes penalties for prepayment

Your bank may impose a penalty if you settle your mortgage before your “lock-in period” (usually the first 3 to 5 years of your home loan tenure) expires. This penalty is typically 2% to 5% of your outstanding loan amount.

Even if you’ve passed your lock-in period, you can still be penalised for making a prepayment, depending on your bank.

Before making an advance payment, check with your bank if these penalties apply, and if they can be waived. Otherwise, these penalties can negate any interest savings gained by an early payoff.

4. If you want to retain mortgage insurance

If you’re covered under mortgage insurance, your loan will be paid off in the event of death, terminal illness or disability. In such situations, you’ll be able to use the extra money to support yourself or your beneficiaries.

However, if you’ve used your savings to pay off your home loan, not only will your savings be tied up in your home, you’d lose the financial buffer provided by your mortgage insurance.

Is it better to pay off my home loan or invest the money somewhere?

Finally, you would want to consider the trade-off between paying off your mortgage loan and using that money to invest instead.

Home loan interest rates in Malaysia can range from 4.2% to 5% per annum. If you can invest your money at a rate of return that outpaces your mortgage interest rates, then it might be worth doing that instead.

For example, let’s look at these scenarios:

1. Shorter loan tenure vs Investing

20-year home loan tenure

                25-year home loan tenure + investing

Home loan: RM600,000
Tenure: 20 years
Interest rate: 4.5%
Monthly Payment: RM3,796The shorter, 20-year loan tenure results in RM311,095 in interest payments – that’s an interest savings of RM89,403 compared to a 25-year tenure.
Home loan: RM600,000
Tenure: 25 years
Interest rate: 4.5%
Monthly Payment: RM3,335The extra five years results in total interest payments of RM400,498 – that’s an increase of RM89,403.However, you pay RM461 a month less. If you invested this amount every month for 25 years with an average of 6% per year, it would grow to RM319,470 (RM138,300 in deposits and RM181,170 in interest).

2. Making small annual payments vs investing

Paying off your home loan

                Investing RM5,000 a year

Home loan: RM600,000
Tenure: 25 years
Interest rate: 4.5%If you contribute an extra RM5,000 a year to paying off your home loan, you could save RM79,242 in interest and pay off your loan four years and five months earlier.
Instead of paying off your home loan, you invest RM5,000 every year for 20 years. If your investments return an average of 6% every year, it would grow to RM183,928 (RM100,000 in deposits and RM83,928 in interest).

3. Making a large payment vs investing

Paying off your home loan

                Investing a RM100,000 lump sum

Home loan: RM600,000
Tenure: 25 years
Interest rate: 4.5%If you contribute RM100,000 to pay off your home loan in the fifth year, you could save RM125,153 in interest and pay off your loan five years and seven months earlier.
Instead of paying off your home loan, you invest RM100,000. If your investments return an average of 6% every year for 20 years, it would grow to RM320,714.

In the scenarios above, investing makes more financial sense. Instead of paying off your home loan earlier, you could make bigger contributions to your Employees Provident Fund (EPF), put your money in Amanah Saham Bumiputera (ASB) or even invest via a robo-advisor.

However, the investing scenarios above assume that you have a long time to grow your portfolio, and that you are comfortable putting your cash in moderate to high-risk investments.

But if these circumstances don’t apply to you – say, if you are nearing retirement;  you may need to reduce your exposure to risky investments. This could mean a smaller rate of return. If your returns do not outpace the interest rate you are paying on your mortgage, then you should consider paying off your mortgage instead of investing.

You may need to make use of mortgage repayment calculators and compound interest calculators to help you determine if the trade-off between paying off your home loan and investing is worth it.

So, should you pay the home loan early?

In short, an early payoff could save you a lot in interest payments. But it may not be a good idea if it depletes your savings, or if you can use your money to settle high-interest debts or invest in a way that outpaces your mortgage’s interest rate.

Of course, if being debt-free is important to you, you can still choose to pay off the home loan early even if it doesn’t make the best financial sense – just as long as you’re aware of and can live with the financial consequences. After all, having no home loan, no debt and fewer monthly payments can feel liberating and you can’t put a price on peace of mind.

This article was repurposed from “Is Paying Off Your Home Loan Early A Good Idea?” on iMoney.com.my | Edited by Reena Kaur Bhatt

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