Recently, we did a webinar session to discuss if we should settle our mortgages, as soon as possible. Of which, we unanimously concluded that it is not prudent, wise, and savvy to settle off our mortgages quickly. However, we had made one exception to our conclusion and I’ll illustrate this one exception below:
Here, we have Richard, a 35-year old senior manager working for a MNC.
When Richard was 25, he bought an apartment for RM 80,000. Today, the same property is valued at RM 150,000 and he has an outstanding mortgage of about RM 40,000 on this property. Richard collects RM 700 per month in rent from his property.
When Richard was 29, he bought a condominium unit for RM 350,000. The unit today is still worth RM 350,000 and his outstanding mortgage is RM 300,000 on this property. Richard currently resides in this property.
Today, Richard intends to buy a terrace house for RM 700,000. He wishes to live in it and thus, will be renting out his condominium unit.
Richard now has RM 300,000 in his bank balances.
His question is, ‘What is the best way to finance his purchase of Property #3?’
Under Normal Circumstances
Richard has outstanding mortgages on two residential properties. Thus, Richard would be required to place a 30% down payment to buy Property #3, which will work out to be RM 210,000. If we budget about RM 35,000 in transaction costs, which is 5% of its purchase price, Richard’s total capital outlay is RM 245,000. In his case, Richard would be left with RM 55,000 in his bank accounts.
Richard could choose to do the following:
Richard can settle off his outstanding mortgage of RM 40,000 for Property #1. It will reduce his number of mortgages on residential properties from two to one. Also, his bank balances will be reduced from RM 300,000 to RM 260,000.
After settling the mortgage for Property #1 in full, Richard is now eligible to buy Property #3 with a 90% mortgage and thus, needing him to put only as much as 10% in down payment, instead of 30% under normal circumstances. Why is this possible? This is because property buyers are eligible to borrow up to 90% of its property price for two residential properties. Since Richard has paid off his first, then, the mortgage for Property #3 would be viewed as Mortgage #2 on a piece of residential property.
Instead of RM 210,000 in down payment, Richard’s down payment works out to be RM 70,000. If we add RM 35,000 in transaction costs, the total capital outlay Richard would incur is RM 105,000. Thus, Richard shall be left with RM 155,000 in his bank accounts, RM 100,000 more compared to normal circumstances.
Now, this is optional for Richard.
After Step 1, Richard has a fully paid apartment worth RM 150,000. He could go to his banker and refinance the property. As this would be his Mortgage #3, the maximum mortgage amount he could qualify for is 70% of the property’s value, which is RM 105,000.
If we include the cost of MRTA of RM 5,000 into Mortgage #3, the installment is RM 423 a month, assuming that he takes a 35-year loan at 3% interest rate. The mortgage installment is lower than his rental income of RM 700 a month and as such, Richard’s RM 105,000 from Mortgage #3 is essentially ‘free money’ and in his case, his bank accounts would now have RM 260,000, up from RM 155,000.
This places him in a better financial position as he has more cash at his disposal and he could use them either as a buffer or to reinvest them to grow his wealth much further.
Yup, that is the only exception as to why one should pay off his mortgage ASAP.
For more information, please check out our latest webinar on mortgages:
If you have any questions related to mortgages, please leave them below: