Update September 2009: MAS no longer allows Interest-Only Housing Loans.
Most people, when considering which housing loan to go for, will usually decide on a principal and interest housing loan. Many are not aware of the option of interest servicing only housing loan packages; of those who do, the majority would summarily dismiss the idea. The notion of never paying off your housing loan can be stomach churning. However, are interest servicing only housing loans really that bad? Interest servicing only or interest only packages do have a primary advantage. The monthly payment is minimised, freeing up your cash for entertainment, investment and other purposes. In fact, proponents of interest only packages believe that such packages give higher Returns on Investment (ROI) compared to a principal and interest housing loan. Let us look at a comparison between the two types of housing loans to see whether this is the case.
Interest Only or Principal and Interest Housing Loan
| Outstanding Loan (3 yrs) | Interest Paid (3 yrs) | Total Payment (3 yrs) | |
| Principal and Interest (P&I) | $470,082 | $50,924 | $80,842 |
| Housing Loan | $500,000 | $52,500 | $52,500 |
The table is computed based on the following assumptions (for definition of terms, log on to our glossary page):
- Property is sold or refinanced after 3 years
- Property appreciates at 5% per annum
- $500,000 loan quantum
- 30 years loan tenure
- Generic 80% LTV floating rate package at 3.25% (1st year), 3.5% (2nd year), 3.75% (subsequent years) (offered by local banks such as DBS and UOB)
- Loan amortization is computed on a monthly rest basis:
- Monthly instalments for a P&I loan are $2,176 (1st year), $2,245 (2nd year) and $2,315 (subsequent years)
- Monthly instalments for an Interest Only loan are $1,354 (1st year), $1,458 (2nd year) and $1,562 (subsequent years)
After 3 years,
Capital Gains = Property Value after 3 years – Initial Purchase Price
= ($500,000 × 1.053) - $500,000 = $78,812
Net Profit (P & I) = Capital Gains – Interest Paid
= $78,812 - $50,924 = $27,888
Net Profit (Interest Only) = $78,812 - $52,500 = $26,312
Interest Only or Principal and Interest Housing Loan
Return on Investment (P&I) = (Net Profit / Total Payment) × 100%
= ($27,888 / $80,842) × 100% = 35%
Return on Investment (Interest Only) = ($26,312 / $52,500) × 100% = 50%
N.B. Total Payment is assumed to be one lump sum paid at the beginning of the loan tenure for simplicity. Actual ROI figures are around double the above as payment is amortized monthly and not in one lump sum.
However, there is more to the ROI (Interest Only) figure than meets the eye. For the interest only housing loan, the capital outlay is only $52,500 compared to $80,842. Assuming that one invests the difference $28,342 ($52,500 - $80,842) in a financial instrument that gives returns after 3 years as stated below:
Interest Only or Principal and Interest Housing Loan
| Returns of 1% per annum | Returns of 3.5% per annum | Returns of 10% per annum |
| $859 | $3,081 | $9,381 |
N.B. Investment is once again assumed to be one lump sum paid at the beginning of the loan tenure for simplicity.
ROI (Interest Only, 1% p.a.) = (($26,312 + $859)/ $80,842) × 100% = 34%
ROI (Interest Only, 3.5% p.a.) = (($26,312 + $3,081)/ $80,842) × 100% = 36%
ROI (Interest Only, 10% p.a.) = (($26,312 + $4,251)/ $80,842) × 100% = 44%
As seen from our analysis, it indeed makes good financial sense to take up an interest only housing loan to maximize your ROI, when the spare funds are invested in financial instruments that give higher returns than the housing loan interest rate. The next time you consider a housing loan, do speak to your housing loan advisor to see whether such packages are suitable for you.