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Many Singaporeans are aware that they have the option of either use cash to CPF pay for monthly home loan instalments. Before we start to discuss whether to pay your property using cash or CPF Ordinary Account (CPF-OA), let’s list out the key facts you need to know:-
- CPF-OA can earn up to you 2.5% per annum. The interest rate in the CPF-OA is reviewed quarterly. It is legislated to be a minimum of 2.5%, or the 3-month average of major local banks’ interest rates, whichever is higher.
- When you use your CPF-OA fund to finance a property, you stop earning 2.5% interest on the sum used. This means the more fund is used for property, the less left for retirement.
- On top of losing the 2.5% annual interest, you will be paying an accrued interest to your CPF-OA account as it deems as “on loan,” which you need to pay back when you sell your property. This means 2.5% interest that you were supposed to have earned during the years you used CPF-OA funds to pay for your property need to be paid pack, on top of the principal sum you had used.
- So when you sell your property, the sale proceeding will be paid out in the sequence order – Bank/HDB first, follows by total CPF-OA funds used for the property, including 2.5% accrued interest. You will only get the excess back in cash if any left.
Accrued interest is simply the amount you would have received in interest returns on your CPF-OA funds if it is not used to pay for the property or housing loan.
To better illustrate and explain whether it is a good idea to pay off your loan using cash of CPF, we use the similar hypothetical scenario we had used in Part 1: Should You Sell Your HDB Flat.
- Both are Singapore Citizens, 30 years old.
- Both earning $5,000 each with combined income of $10,000.
- They bought a 4-room HDB BTO in a mature estate at $450,000.
- They were the first-timer, and their BTO flat will be near to their parents’; thus, they will get a total of $70,000 of HDB grants (i.e., $50K for 1st-timer grant and $20K for proximity grant).
- They decided to go for a HDB loan instead of a bank loan.
This means they will be contributing $27,600 yearly to their CPF-OA. Given CPF-OA interest of 2.5% and assuming they have been working for 5years, they should have a combined CPF-OA fund of about $145,000 at the time of purchase of the BTO flat.
Yearly CPF-OA = ($5,000 x 23%) x 12 months = $13,800
5 Year CPF-OA Amount = $13,800 x (1+0.025)^5years x 2 persons = $145,000
To make things simple, let’s assume:-
The table below illustrates the 3 different options for financing the flat.
Option 1 – Using 100% cash to pay for the monthly HDB loan
Option 2 – Using 100% CPF-OA fund to pay for the monthly HDB loan
Option 3 – Using 50% cash and 50% CPF-OA to pay for the monthly HDB loan
The total HDB loan repayment with a loan amount of $335,000 @ 2.6% p.a is $455,938 at the end of 25 years. The total interest paid will be $120,938.
The CPF-OA used for 10% downpayment is $43,000 (as the option fee $2,000 would have been paid in cash), the balance of the couple CPF-OA will be $145,000 – $43,000 = $102,000 will be continued to earn on the interest of 2.5% p.a.
From the comparison table of the 3 options, you can see that using the CPF-OA fund to pay off your housing loan fully is NOT the most ideal option, ESPECIALLY if you want to HOLD ON to the property for a longer period.
For Option 1: 100% by Cash, when the couple uses cash to repay their monthly home loan, they will continue to add their monthly CPF contribution to their CPF-OA account. In return, their retirement fund will accelerate due to a compounding interest of 2.5%.
Moreover, if they decided to sell their HDB at any time after 5year MOP, they will receive more cash as there is no return of any fund back to CPF. However, if they decided to stay in the HDB for their old age, they can continue to accumulate their CPF retirement fund.
If the couple chooses to repay their home loan using Option 2: 100% from their CPF, they will stop earning the 2.5% interest on the fund they withdraw to pay for the housing loan. Moreover, this will also mean they have to pay back CPF on what they had withdrawn together with the accrued interest of 2.5% of the sum used if they decided to sell after meeting 5 years MOP. This will leave them with less cash, and if any negative sale in which the HDB is sold below market value, they may have to pay the difference in cash.
Of course, the couple can choose Option 3 to finance their home loan using partially cash payment, i.e., in this case, 50% cash and 50% CPF. In this way, they can still accumulate for the CPF retirement fund.
Over here, it is not saying you should not use CPF to pay off your property. It would help if you could consider:-
- Opportunity cost may be lost when using CPF as immediately you will stop earning at least 2.5% interest. On top of this, the accrued interest of 2.5% incurred on the amount you used to pay the property will deduct away from the cash return back to your CPF when you sell the property. This amount can be used for other investments or buying another property.
- Reduced your future retirement fund as you will lose the exponential growth of the compounding interest. Compound interest is interest earned on money that was previously earned as interest. Assuming you have not used all your CPF-OA fund, your principal amount, i.e., downpayment plus monthly CPF contribution will continue to grow. It is a snowball effect – the longer you put in the CPF account, the more you benefit from compound interest. Using all CPF-OA funds to service your property loan reduces the CPF amount and lower retirement savings for future needs.
- Risk of over-commitment if you are not disciplined enough to set aside cash savings. If you don’t have a budget plan or develop the habit of saving and spend most of your net income, you may run into financial risk in the event of retrenchment, economic downturn, or other financial burdens.
If you understand CPF is meant for retirement and you can always fall back to use your CPF-OA fund to repay your housing loan in the event you run into any financial risk, you should allow your CPF savings to enjoy the interest rate and let it grows. However, if you have other forms of investment that can generate more than 2.5% p.a. to grow your retirement fund, CPF is more like a safety net if any other investments failed, you still have your CPF.
If you do not have enough cash to start with, definitely CPF fund is a good source to start with as buying a home or invest in property is not always at the right timing. You can still realize your dream of making a property investment if you have assessed your financial health. In the next section, you will find out how using CPF for property may give you more options.