Sunday, 29 September 2013

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.

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  1. When you are near 55 and you still have outstanding housing loan and plenty of idling cash in the bank and too worry to invest; then it make more sense to pay up with cash.

  2. Wow, it's interesting that singapore has a very favorable mortgage term. Here in the US, the government give the bank the money at 0% interest, but by the time it gets to me, I had to pay 4.375%. Double the amount of interest you pay there in singapore.

    1. Yes, the loan interest is quite low as it caters for public housing and is provided by a provident fund managed by the state. The fund currently pays 2.5% for the savings and charges 0.1% more for the housing loans. The savings interest rate is tied to commercial deposit rates, but has a floor at 2.5%.

    2. cos houses are relatively cheaper in the USA :)

  3. Hello Chin Wai,

    I just wish to understand this a little further. Your assumption is based on saving monies on hand vs saving monies in OA hence 0.05% vs 2.5%, am I right to say so? But that's if we have ready cash.

    Does this apply to using bank loan (1.8% and rising) vs using OA (2.5%) to service mortgage as well? Which of the two will you advocate?

    1. Hi fitree,

      Yes, the computation is comparing saving money on hand with saving money in OA.

      Is your second question about whether it is better to take a bank loan or CPF loan? As you've correctly mentioned, bank loan interest rate is on the rise, so it's safer to take CPF loan instead.

    2. Thank you for the clarification, Chin Wai. Your blog is indeed one more of the more pragmatic ones around. Carry on writing yeah; I know it can be tough at times!

    3. Thanks for your encouragement. I'm glad that it is useful to you :)

  4. Hey Chin Wai,

    Interesting perspective from you.
    I'm planning to apply for BTO next year and this post got me thinking.
    Paying with cash leaves little cash flow for me, and thus, giving me lesser cash for investing in index,bonds and endowments.

    (I prefer to hold investments for long term to accumulate and reinvesting dividends)

    What is your advice?

    1. Hi Yong Jie,

      You can use the potential rate of return of cash and CPF to guide you. If you plan to invest using cash, then cash will likely have higher potential returns than CPF, so it'll be better to use CPF to service the loan. On the other hand, if cash is left in the bank at low interest rates, then it is better to service the loan using cash.

    2. Hi Chin Wai,

      Thanks! I believe using cash to invest in index will provide a better yield in the long run. So I will more likely to opt for using CPF to service the loan. Thank you for your reply.

    3. Hi Chin Wai and Yong Jie,

      I am thinking of applying BTO as well and have been researching on this topic and i found out that we have to pay back the CPF money we used for HDB with accrued interest till the day we sell our HDB. I am interested to hear if this will affect your views on this matter.

    4. Hi Ivor,

      No, it does not affect the decision whether to use cash or CPF to service the loan. The rule just means that you need to put more money back into CPF when you sell your flat. It is akin to deciding how to distribute your profits after the investment is sold; it does not affect the original investing/ financing decision.

  5. Hello,

    Can I check something regarding the CPF top-up option. In this scenario, since I am still paying by CPF, is the accrued interest still accumulated? If so, that accrued interest is always 0.1% above OA rate and so they should cancel out right? (I may be entirely wrong on this though.)

    1. Hi,

      Yes, accrued interest is still accumulating. The accrual interest rate is the same as the OA rate, since accrued interest reflects the amount of interest you would have if you had not used the CPF money for repayment.

      FYI, you can apply to CPF to pay back the accrued interest with cash. This is different from cash top-up.

  6. Hi, I've tried to find in cpf website on what is the limit of SA but i can't find it. And matter of fact, i was informed that SA had no ceiling limit, so how does SA can overflow to OA?

    Bit confused now

    Thanks in advance for your reply

    1. Hi, you are correct. There is no limit on SA. Thks for pointing it out.

    2. Good to clear that up. After some reading, you can overflow your MA to your SA if your MA hit the ceiling limit (Currently 52K), and if your SA has reached FRS (currently 166K) it will overflow to OA instead.

    3. Yes, you are correct. To summarise, when MA hits the MA ceiling, MA contributions will overflow to either:
      (a) SA, if SA has not reached FRS, or
      (b) OA, if SA has reached FRS.

      SA has no ceiling, so SA contributions will not overflow to OA when SA reaches FRS.

  7. i am in a dilemma regarding using cpf vs bank (cash) too. have been researching this for the longest time..

    with fed due to increase in the next few years, which means, the sibor will also rise. do you think that bank i/r will be more than hdb loan? is there any precedence for this happening?
    or once bank loan rises to the same level as hdb loan, the hdb will increase their i/r too? (ie the cpf oa has to increase too, since it is pegged +0.1%)

    btw, did u use cash or cpf for your house?

    1. Sorry, I missed your comment earlier.

      CPF OA interest rate is set at 80% x banks' fixed deposit rates + 20% x banks' savings rates, subject to a min. of 2.5%.

      Banks have a type of loans that are also pegged to fixed deposit rates. The rates are set at fixed deposit rate + margin. Hence, banks' loan rates will generally be higher than HDB loan rate. They are currently lower mainly because CPF OA rate has a floor at 2.5%.

      I'm using CPF to service my housing loan.

  8. no worries.

    reading from your post, it seems using cash is the most efficient use (keep cpf intact). any reason why u still cpf to service your loan then?

    1. It's because I invest the cash, hoping to achieve a return higher than CPF's 2.5%. If I could achieve a higher return than CPF, then it is better to use CPF to service the loan.

    2. what do you invest in to beat CPF's interest rate?

    3. Money Maverick,

      I invest in shares and corporate bonds.