Home Loan - Does inflation help you reduce the amount of interest you pay?

[flinger]

Hi,

Appreciate everyone opinion / advice on this.

Scenario is as follows :

If you take up a fixed loan like HDB loan at 2.6 % for a loan amount of 350,000 dollars.

Wouldn't it be better to take the loan as long as possible since its a fixed rate loan for the next x no. of years. Also since you will be paying using future dollars, in the total amount, wouldn't you be paying lesser?

So I used a loan calculator that incorporates inflation into the total amount to validate that. Below are the results.

Mortgage Principle - S$350000
Mortgage term - 25 years
Yearly mortgage interest rate - 2.6 % fixed
Expected yearly inflation rate : 3 % flat rate every year.

Results :
-----------------
Monthly payment : $1,587.85 (Today dollars)
Falling to $749.35 (Adjusted for Inflation)
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Principal payments $350,000.00 (Today dollars)
$236,072.25 (Adjusted for Inflation)
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Interest payments $126,352.99 (Today dollars)
$98,490.55 (Adjusted for Inflation)
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Total payments $476,352.99 (Today dollars)
$334,562.79 (Adjusted for Inflation)

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It seems from the results that , it would actually be better to extend the loan and pay in future dollars. The total amount I pay is lesser then what I borrowed to pay.

Now my question is.... Is there something wrong in the way I am looking at it ?? Am I missing something and the results are actually wrong?

I have attached the month by month breakdown provided by calculator if anyone in interested in the breakdown.

Appreciate if you could help correct if I am wrong in my outlook and calculation.

Thank you .



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[godjira1]

Sorry but dbs 2.6 is for how many years? Your logic is sound to me but i am just curious.... I would borrow big time @2.6 if its a 30 year fixed!

Most mortgages offered now are ARMs with low teasers. If you can refinance (ie prop keeps going up) and i/r stays low, all is well. Obviously if prop prices fall together with an increase in i/r then the ARM holders are in danger.

[flinger]

Sorry but dbs 2.6 is for how many years? Your logic is sound to me but i am just curious.... I would borrow big time @2.6 if its a 30 year fixed!

Most mortgages offered now are ARMs with low teasers. If you can refinance (ie prop keeps going up) and i/r stays low, all is well. Obviously if prop prices fall together with an increase in i/r then the ARM holders are in danger.

Hi godjira,

This is a HDB ( Singapore Housing Development Board) fixed rate Loan that offers 2.6% for housing ,not a commercial loan from a bank.

[corydorus]

Few assumptions have to be make i think.

1. Spare cash equal to the amount you plan to loan right now in saving account not being utilized for the 2.6% loan.
2. Invest the entire sum (on top of your other investments), and can get more than 2.6% returns consistently for 30 years. (Compounded for 30 years ?)
3. 2.6% rate will not change for 30 years.

Cory

[flinger]

Few assumptions have to be make i think.

1. Spare cash equal to the amount you plan to loan right now in saving account not being utilized for the 2.6% loan.
2. Invest the entire sum (on top of your other investments), and can get more than 2.6% returns consistently for 30 years. (Compounded for 30 years ?)
3. 2.6% rate will not change for 30 years.

Cory

Hi Corydorus,

I think maybe you have misunderstood me. My question is not if I have a lump sum of money should I pay the housing loan and save on the interest or should I invest it as I might be able to get more than 2.6 % and thus stretch the loan for 20 plus years.

My question is more on : If I borrow in today's dollars and pay in future dollars for a fixed loan of 2.6 % for 25 years . In terms of total payment I would actually be paying less than what I borrowed as majority of the payment is in future dollars.

I wanted to validate if that is correct? Am I missing something there?

Hope that makes sense.


Thank you.

[godjira1]

If inflation is higher, or your alternative return is higher, yes u will come out ahead.

[mysterion]

Hi Corydorus,

I think maybe you have misunderstood me. My question is not if I have a lump sum of money should I pay the housing loan and save on the interest or should I invest it as I might be able to get more than 2.6 % and thus stretch the loan for 20 plus years.

My question is more on : If I borrow in today's dollars and pay in future dollars for a fixed loan of 2.6 % for 25 years . In terms of total payment I would actually be paying less than what I borrowed as majority of the payment is in future dollars.

I wanted to validate if that is correct? Am I missing something there?

Hope that makes sense.


Thank you.

Only makes sense if inflation is higher than interest rates. Once interest rates increase beyond inflation, you will be paying more than what you borrowed.

[hyom]

Hi flinger,

I think your strategy will work fine in a high-inflation-over-many-years environment. However, Cory's assumption that the interest rate remains fixed throughout 25-year period is a critical one in Singapore's context. The last time I asked almost 4 years ago, there are no such thing as a 25-year fixed interest rate bank loan in Singapore. The interest rate will reset every 3 years. Because of this constraint, your strategy will not work in Singapore but will work in US where 30-year fixed interest rate loan is available.

HDB interest rates are not fixed at 2.5%. They fluctuate with the interest rate in our CPF ordinary account.

If someone knows of mortgage loans which fixes interest rates for longer than 10 years, please do let us know. Thank you.

[godjira1]

Hyom, thx. I didnt know hdb loans reset every 3 years

[hyom]

Hyom, thx. I didnt know hdb loans reset every 3 years

Oops. I was not clear enough. HDB fluctuates with interest rate in CPF ordinary account. The 3-year interest rate reset applies for the bank mortgage loans that I enquired 4 years ago. Today, I am not sure but as a matter of risk management, I think our banks could be still sticking to the same rule. General consensus is that inflation is likely to remain high with all the money printing going around in the central banks of the developed world.