Imagine this.
Years ago, you bought an apartment for investment.
The cost was RM150k and you’d borrowed RM135k in mortgage to pay for the apartment. Since then, you’ve earned RM700 a month in rental income. This covered your mortgage interests and all other related costs.
Today, the apartment is worth RM300k. Your outstanding mortgage is RM100k. You now receive RM1k a month in rental income, which covers both your mortgage interests and related costs. In essence, from the first day to the present, you broke even each month. Every year, you reported a net rental income of RM0.
At present, you have RM100k in excess cash. The question is: “Would you settle your mortgage with your excess cash?”. Is it financially smart to do so?
Let’s discuss.
In this article, I’ll share three main factors to consider to better decide on this.
Factor 1 – Personal Income Tax Bracket
Are you still actively earning income as a salaried man or a business person?
If so, how much are you making in active income each year?
If your active income is above RM100k a year, your personal tax bracket is at least 25%, for any amount that you earn in excess of RM100k. Hence, to lower your final tax payment, you need to be tax savvy by utilising tax reliefs made available to you by the government.
But, if you are a retiree, who lives off investment income (dividends and interests from FDs), you may be paying little or no income tax at the moment.
Still, in any case, you want to minimise the income tax payable from rental income. This is easily done by deducting all deductible expenses from your rental income. One of them is your interest expenses from your mortgage.
Take the above example.
Let’s say the mortgage interest rate is 4% a year. Based on your mortgage outstanding and your monthly installments, you would be paying around RM3500-RM4000 in interest costs in the next 12 months. Hence, by using the RM100k in excess cash to settle your mortgage balance, you’re able to save RM3500-RM4000 in interest costs.
But, as you have less deductible expenses, your net rental income goes up by RM3500-4000. In that sense, if your personal income tax bracket is 25%, you might be paying RM875-1000 in tax. In the end, the net savings you’ll receive is RM2625-RM3000 in the next 12 months from paying off RM100k in mortgage outstanding.
Your effective return from utilising the RM100k in excess cash is 2.625%-3.000%.
Does it sound impressive to you?
Factor 2 – Cost to Unlock Your Cash
Once you’ve paid off your mortgage, congratulations! You own the property debt-free. You could be feeling a sense of emotional triumph from it.
Here’s another question: “What if you need some cash in the future?”
Can you “withdraw” the RM100k from your apartment?
Technically, that is known as refinancing. It’s doable and it comes with charges such as legal fee to draw up a new loan agreement, its stamp duty and a new property valuation report. They may cost you around a few thousand ringgit (depending on the property’s market value) to unlock the equity within your property.
This means – It’s easy to pay off your mortgage. But, it’s not easy to unlock the equity within.
Factor 3 – Opportunity Costs
The RM100k may seem like idle money but it could serve you, both financially and emotionally.
Assuming you did nothing else with it but place it into FDs, ASB, or cash platforms to earn some interests or dividends annually. Beyond finances, the RM100k could provide you with a freedom, which enables you to take on more meaningful work (not just work for short-term money), take a short break, go on a vacation, pay for minor emergency bills without being worried about money, and so on and so forth.
RM100k today may not be as much as what it used to be before.
But still, it is a good enough sum for a lot of us to enjoy some choices in life.
Of course, if you happen to be a savvy investor, the RM100k is capital that allows you to pursue investment opportunities when they arise. What’s the point of paying off your RM100k mortgage, which could yield 2.625-3.000% a year, when you can invest for 10%-20% in returns per year?
With that being said, you first need to be savvy in investing before you pursue this path.
Conclusion:
There are a dozen ways to better utilise excess cash than to reduce mortgage balance. But, this requires you to be comfortable with owing low-interest debt. Even if you are not financially savvy personally, the excess cash-in-hand is still a valuable resource that offers you liquidity. Hence, in most cases, it is still better to keep the cash without paying off the mortgage in advance.
Still, we would encourage all to become financially smarter. Being so allows you to have choices as to how best to deploy this RM100k to maximise the potential of your capital safely, securely & smartly. That’s the power of financial education.
