Owing your bank money can be stressful. 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.
For sure, paying off that huge loan will mean paying less in interest charges to the bank. But this isn’t always the best financial decision – here’s what you should know before you settle your home loan early.
Paying off your home loan means less interest
The faster you pay off your home loan, the less interest you pay. Here are a few ways you can pay off your home loan early:
Scenario 1: Refinancing to a shorter-term 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 loan with a shorter loan tenure. Here’s how different loan tenures affect your interest payments:
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’ll need to make sure that you can cope with the higher monthly instalments that come with it:
| Monthly instalment for a RM600,000 loan at 4.5% interest rate p.a. | |
|---|---|
| Loan tenure (years) | Monthly instalment |
| 10 | RM6,218 |
| 15 | RM4,590 |
| 20 | RM3,796 |
| 25 | RM3,335 |
| 30 | RM3,040 |
| 35 | RM2,840 |
Scenario 2: Making small, recurring partial capital repayments
What if you put away extra cash – 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 your loan years earlier. Here’s an example of how much you could save if you made an extra RM5,000 payment every year on your home loan:
Note: The Overpayment calculator was used for these calculations
Scenario 3: Making a large capital repayment
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
When should you not pay it off early?
Although having to pay less interest on your home loan is a compelling prospect, here are a few situations in which it may not be the best route:
1. If it depletes your savings
You shouldn’t 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 settling your home loan early.
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 your extra savings 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.
Paying off your home loan vs investing
Finally, you’d 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% p.a. 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 repayment: RM3,796 The 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 repayment: RM3,335 The 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’re 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’re 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 settle your mortgage early?
In short, paying off your mortgage early 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 your 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.
