To Pay-off or Not to Pay-off?

For the past few days we have been debating whether it makes sense to pay off a housing loan in India by taking a cheaper interest bearing loan in Singapore and following the suggestion of one of the readers I decided to make a post dedicated to housing loans.
Before answering the question of paying off a more expensive loan with a cheaper one in Singapore, let me list down some of the aspects that can influence the decision.

  1. An interest payment on a housing loan tends to be around 2 to 3 % higher than the interest that one would earn on a NRE FD.
  2. The principal payment on a Housing loan is deductible from taxable income upto a amount of Rs. 150,000 per annum.
  3. The deduction on housing loan under section 80 C is subject to the overall limit of 150,000 which includes payments made life insurance payments, PPF, ELSS, Tax saving fixed deposits etc.
  4. The deduction under 80C for housing loan is only for the principal paid in a given financial year and not the interest portion of the EMI paid. Which means that tax benefit on account of housing principal payment will increase gradually over the term of the loan.
  5. The interest paid on the home loan is deductible under section 24 of the income tax act and if you look at the table below it would gradually decrease over the period of the loan. This interest is deductible upto Rs. 200,000 per annum.

Adding benefits under section 24 and 80C one could theoretically deduct Rs. 350,000 per annum of EMI paid subject to limits imposed by individual sections . Benefit under both sections is available to NRI’s.

The tax benefit can change over the period of the loan as the benefits under SECTION 24 and 80C can be revised as a part of the yearly budget exercise.

These tax deductions are beneficial only if one has taxable income for the year.

Another important factor to consider would be any penalty that your bank might impose for early repayment of the loan.

To help with further discussion, I have created the below widget where you can enter the amount of the loan, the interest rate, term of the loan and the year in which loan was taken to get the EMI and payment schedule (rounded to first integer).

If you observe then during the first few years one’s EMI mostly covers the interest payment and less of principal amount and the situation  reverses as the time passes by.

However the interest rate that one is paying remains constant throughout the tenure of the loan irrespective of whether it’s the first year or the last. By virtue of decreasing outstanding loan amount (principal amount) the EMI covers more of principal over time and helps pay off the loan.

Therefore it would be wise to take a cheaper loan in Singapore to pay off a expensive loan in India subject to:

  1. The total differential in interest rate is in favor of the cheaper loan.

E.g. If the current loan is at 9.6%, the loan prepayment penalty is 1%, the tax bracket in which the individual is 30% and total emi is less than 29k per month then the break even point for the new loan in Singapore would be a effective interest rate of 5.72%

2. If the person is in a lower tax bracket or has no benefit by way of deductions from housing loan then the break even point above would be 8.6%

3. The individual taking a personal loan in Singapore or any other country has relative certainty of continued cash flow or employment for the tenure of the loan.

Also one should remember that the loan repayment (interest and principal) of the loan taken in Singapore or any other country does not qualify for any tax rebates in India.

Other factors like expected future exchange rates, anticipated changes to tax laws, whether one has a fixed rate loan or floating rate facility and outlook of interest rates can also be considered but the more variable one adds the more complicated the decision making process will become.

In Singapore you can avail a personal loan upto 4 times your monthly salary. So if both husband and wife work you can get a bigger loan.

Citibank, in my experience tends to offer best rates for 6 months personal loan (if you have been a regular customer). Dbs and HSBC tend to offer the worst rates from what I have heard from acquaintances. Loans longer than 6 months tend to cost more from banks and tapping into into family, friends or Bullion backed facilities are other good alternatives.

The bottom line is that an expensive loan should always be paid off or replaced by a cheaper loan. The same applies if your investment yields less than the cost of home loan then sell off your investment  and reduce your debt first- remember every penny saved is every penny earned.

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4 thoughts on “To Pay-off or Not to Pay-off?”

  1. I have just received a cheque in my mail from ANZ. It is 0% interest rate and also 0% processing fee for 6 months. It is on my credit card which has a limit of $7.5K. I can take upto 95% of my credit limit. I dont see any harm in using this cheque. It is free. But I am not sure what to do with the money. I have no loans. I could just keep this money in my OCBC 360 account and earn paltry 1.3% interest or just transfer to India, but rates are bad right now. Any thoughts?

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    1. You could invest in a money market mutual fund which would yield between 2 to 4%. It’s free 75$ to 150$ over 6 months. I think they are hoping that one would forget making monthly minimum and the charges for that will earn them money. If you transfer you break even rate would be 48.60 in 6 months which is a realistic rate. If you want to take a little but more risk then transfer to India and invest in ipos lined up for March and you could make a decent return of 10% or more

      Liked by 1 person

    2. Thanks. Regarding this part: ” I think they are hoping that one would forget making monthly minimum and the charges for that will earn them money.”

      It could also be that they want to charge me the annual fee this time. Last time around they charged me annual fee and I requested them to waive it off. If they didnt I would have closed the card. I heard ANZ is making it hard for people to waive off their annual fee, especially those who made good use of the rebates. I am talking of the ANZ optimum card. I will look up when my annual fee is due.

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    3. There is so much competition out there that it will be stupid for any bank to try and charge credit card annual fee. Bank of China has a family card which is fantastic and so is the UOB one card. Bank of China has the added benefit of earning interests upto 3.55% if you have the multi currency account with them.

      Liked by 1 person

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