Yes, you should pay off your mortgage early – if you’re able to.

That doesn’t mean that you have to come up with $100,000 or $200,000 by next Tuesday or something. What we mean is that you should consider paying more towards your monthly mortgage payments if possible. Why? High interest rates. The threat of higher interest rates down the line is just part of the reason why. 

The overarching drive behind paying off your mortgage as early as possible lies in how home loan interest is calculated in Singapore, which is what this article will explain. 

Mortgage Loan Calculator

The interest on home mortgages is calculated on an amortisation (means it’s deducted off by regular payments) basis, or reducing balance basis. This method allows you to pay the interest on your loan while also paying down your principal with each monthly instalment. 

Mortgage Interest Rates: How is it calculated?

A mortgage home loan’s interest payable each month is calculated using the following formula:

  • (Outstanding loan amount x Interest rate) ÷ 12 = Monthly interest

This means that the amount of interest paid is the highest at the start of the mortgage, and decreases with each subsequent payment. At the same time, the amount paid into your principal starts off small, and increases each month.

Here’s a quick example to help illustrate amortisation in action. 

Assuming a mortgage loan of $300,000, with a tenure of 20 years, and interest of 4% per annum.

Using this handy amortisation calculator, we get this mortgage loan summary:

  • Monthly payment: $1,818
  • Total interest paid: $136,306
  • Total cost of loan: $436,306
  • Last payment due: Dec 2042 (20-year term, starting on Dec 2022)

Monthly Home Loan Payment Table

Here’s what the numbers look like in the beginning and at the end of the mortgage. Note that the total amount paid each month (interest + principal home loan amount) remains the same.

MonthInterest paidPrincipal paid

As shown above, the interest charges in the first month takes up more than half of the total payment. This is because the outstanding loan amount is the highest at the point in time. 

Because a portion of the total monthly payment goes towards the principal, the outstanding loan amount is reduced in the next month. This, in turn, results in a lower interest charge for the month, which means slightly more is paid into your principal the next month. 

This process goes on throughout the loan tenure, with the interest decreasing and the principal increasing.

Photo: 123RF

Pay more mortgage each month

Extra Payment Mortgage

What happens if we pay more into our mortgage each month, say, by $100? Let’s take a look at the numbers.

Loan summary (with $100 extra payment each month)

  • Monthly payment: S$1,918
  • Total interest paid: S$124,692
  • Total cost of loan: S$424,692
  • Last payment due: Jun 2041

Increasing your mortgage payment by S$100 each month creates two beneficial outcomes. One, the total interest paid is lowered – by around S$12,000 in our example. 

Two, the last payment date is brought forward by a whopping 18 months, which means you can free up your cashflow much earlier, to put towards other uses. 

This is all happening because the outstanding loan amount decreases by an additional S$100 each month, accelerating the entire cycle.

Mortgage interest rates increase

When the interest on your mortgage increases (and if the tenure remains the same), the amount you have to pay each month will go up – there’s simply no way around it. 

Here’s a side-by-side comparison showing what happens if the interest rate goes up a mere 0.5% – from 4% to 4.5%.

 Mortgage interest: 4%Mortgage interest: 4.5%
Monthly paymentS$1,818S$1,898
Total interest paidS$136,306S$155,508
Total cost of loanS$436,306S$455,506

With just a mere 0.5% increase, you’ll end up paying over $19,000 more in interest over the course of your mortgage. If that’s not discomfiting enough for you, go to the calculator linked above and put in some bigger numbers. We dare you. 

Perhaps what’s more worrying is the immediate increase in your housing costs, as some Singaporean homeowners found to their dismay earlier this year when interest rates spiked.

long weekend hong kong skyline

Pay off mortgage early

Okay, buckle up people, because it seems that things are going to get worse before they get better. OCBC expects interest rate hikes to continue into 2023, while DBS foresees mortgages to go up by as much as $1,000 each month.

So, given the coming storm, doesn’t it make sense to simply hold on to your money and tough out the coming rise in housing costs?

Yes, this approach will allow you to “roll with the punches”, so to speak, and it is important to prioritise everyday expenses given how shaky the global macroeconomic situation is right now. 

However, if you have the cash to spare, paying more into your mortgage now will allow you to build up a buffer that can help you better absorb any interest rate increases that come your way. 

And, if interest rates remain more or less the same, or go down, then you’ll be able to pay off your mortgage quicker, and save a chunk on interest charges – as demonstrated earlier. 

This article was originally published on SingSaver.