Housing Loan Servicing – Cash or CPF?

Should you use cash or CPF to service your housing loan? Most people would use CPF, so as to conserve the cash for other purposes. Moreover, CPF money is considered as being "locked up", so you cannot use it for most other purposes. However, if you have the cash, does it make financial sense to service the housing loan using cash?

The main argument for using cash to service the housing loan is because interest rates for cash savings are so low, at around 0.05%, whereas the interest rate for CPF Ordinary Account (OA) is at 2.5%. By using cash to service the loan and keeping CPF untouched, effectively, you gain 2.45% on the loan repayment annually. Considering the effect of compounding over time, this can add up to quite a bit of money over the length of the loan tenure.

Besides these 2 options, there is a middle option, which is to service the loan using CPF and top-up the CPF using cash. Effectively, you are servicing the loan using both cash and CPF. (Note: the cash top-up into CPF goes into the Special Account (SA). When the upper limit for SA is reached, the balance will overflow into OA that is used to service the loan. But when the limit is reached, it also means that no further top-ups are allowed under the Minimum Sum Scheme). When you top-up CPF using cash, you can also claim for tax deduction for up to $7,000. If your marginal tax bracket is 7%, that means a tax savings of $490 annually. That can also add up to quite a bit of money over time. So, the question is which option makes the most financial sense -- servicing the loan using cash, CPF or CPF top-up?

To answer this question, let's consider the following scenario:

Loan Details
Loan Principal	$200,000
Loan Tenure	25 years
Loan Interest Rate	2.60%
Annual Loan Repayment	$  10,980
Income Details
Annual Income	$  60,000
CPF	$  12,000
Annual Taxable Income	$  48,000
Annual Income Tax	$    1,110
Cash	$  46,890
CPF Top-up	$    7,000
Cash Interest Rate	0.05%
CPF Interest Rate	2.50%

Let's further assume that all the cash earned is not spent but saved in the bank. At the end of the 25-year loan tenure, the total amount of cash + CPF for the 3 options are as follows: 

	Using Cash		Using CPF		CPF Top-Up
Year	Cash Bal	CPF Bal	Cash Bal	CPF Bal	Cash Bal	CPF Bal
0	$             -	$             -	$             -	$             -	$             -	$             -
1	$      35,910	$      12,000	$      46,890	$        1,020	$      40,380	$        8,020
2	$      71,838	$      24,300	$      93,803	$        2,066	$      80,780	$      16,241
3	$     107,785	$      36,908	$     140,740	$        3,138	$     121,201	$      24,667
4	$     143,749	$      49,830	$     187,701	$        4,237	$     161,641	$      33,304
5	$     179,731	$      63,076	$     234,685	$        5,363	$     202,102	$      42,157
6	$     215,731	$      76,653	$     281,692	$        6,517	$     242,583	$      51,231
7	$     251,749	$      90,569	$     328,723	$        7,700	$     283,084	$      60,532
8	$     287,785	$     104,833	$     375,777	$        8,913	$     323,606	$      70,066
9	$     323,840	$     119,454	$     422,855	$      10,156	$     364,148	$      79,838
10	$     359,912	$     134,441	$     469,956	$      11,430	$     404,710	$      89,854
11	$     396,002	$     149,802	$     517,081	$      12,736	$     445,292	$     100,121
12	$     432,110	$     165,547	$     564,230	$      14,075	$     485,895	$     110,644
13	$     468,237	$     181,685	$     611,402	$      15,447	$     526,518	$     121,430
14	$     504,381	$     198,227	$     658,598	$      16,854	$     567,161	$     132,486
15	$     540,543	$     215,183	$     705,817	$      18,295	$     607,825	$     143,819
16	$     576,724	$     232,563	$     753,060	$      19,773	$     648,508	$     155,435
17	$     612,923	$     250,377	$     800,327	$      21,288	$     689,213	$     167,341
18	$     649,139	$     268,636	$     847,617	$      22,840	$     729,937	$     179,545
19	$     685,374	$     287,352	$     894,930	$      24,431	$     770,682	$     192,053
20	$     721,627	$     306,536	$     942,268	$      26,062	$     811,448	$     204,875
21	$     757,898	$     326,199	$     989,629	$      27,734	$     852,233	$     218,017
22	$     794,187	$     346,354	$  1,037,014	$      29,448	$     893,039	$     231,488
23	$     830,495	$     367,013	$  1,084,422	$      31,204	$     933,866	$     245,295
24	$     866,820	$     388,188	$  1,131,855	$      33,005	$     974,713	$     259,448
25	$     903,164	$     409,893	$  1,179,311	$      34,850	$  1,015,580	$     273,954
Cash + CPF	$1,313,057		$1,214,161		$1,289,535

As shown in the scenario above, using cash to service the loan is still the best option. Using only CPF to service the loan is always the worst option because of the higher CPF interest rate. Although the CPF top-up option generates tax savings, the amount of tax savings is insufficient to compensate for the loss in interest for keeping as much money in the CPF as possible.

There could be other scenarios in which the CPF top-up option might be better than the cash option. Some of the factors that could affect the outcome are as follows:

• Cash interest rate versus CPF interest rate. By design, the CPF interest rate will always be higher than the cash interest rate. The higher the CPF interest rate relative to the cash interest rate, the more beneficial it is to keep as much money in the CPF as possible. But when the cash and CPF interest rates are close to each other, the tax savings from CPF top-ups will make this the best option.
• Amount of CPF top-up versus CPF draw-down for loan repayment. In the scenario above, the amount of CPF top-up is $7,000 while the amount of CPF draw-down to service the loan is about $11,000. Hence, $7,000 of the loan repayment is serviced by the cash top-up into CPF while $4,000 is serviced by money originally in the CPF. Over the loan tenure of 25 years, the tax savings from CPF top-ups is insufficient to compensate for the loss in net interest from a smaller CPF balance. If the amount of CPF top-up and draw-down is close to each other, the tax savings from CPF top-ups will make this option the best one.
• Loan tenure. As explained above, the longer the loan tenure, the larger is the compounding effect of the higher CPF interest rate.
• Marginal tax bracket. In theory, the higher the marginal tax bracket, the greater the amount of tax savings from CPF top-ups. However, you will need a really high income for the tax savings to outweigh the loss in net interest and the effects of compounding.

In conclusion, based on the current interest rates and policies, using cash to service the housing loan usually makes the most financial sense. Nevertheless, servicing the loan using CPF and topping-up the CPF using cash provides greater flexibility in the future when interest rates and policies might change.


See related blog posts:

• Clean Out CPF Balance When Taking HDB Housing Loan?
• Is CPF Accrued Interest Double Counting of Housing Loan Interest?
• Stretch Loan & Invest the Rest