The question of paying off a Housing and Development Board (HDB) apartment fully from Central Provident Fund (CPF) has been brought up recently, and some commentators have suggested that it is an unequivocally BAD idea. The general argument is that having withdrawn a sum from CPF to fully pay up a property incurs an “interest” of 2.5% per annum, which must be placed back in CPF, along with the principal sum, when the property is sold. The example given is that taking SGD300,000 from CPF to pay off a property would require a replacement sum of more than SGD600,000 if the property is sold after 30 years. That’s over 100% in “interest” total!

But we ask, where does this “interest” go, and what is the alternative to paying off the property in full?

Before we explore this further, let’s go through some numbers and definitions.

- Currently, the CPF Ordinary Account (CPF OA) interest rate is 2.5% per annum.
- Also, the interest rate on a HDB housing loan is 2.6% per annum, with maximum tenor of 30 years.

The options available then are:

- Pay off fully from CPF
- Take a HDB loan
- Take a bank loan

**Option 3** produces the best gains in terms of interest paid, with the caveat that bank rates remain at the current low point. To us, it’s somewhat of a gambler’s option, and could go either way depending on future interest rates. In either case, this option is not the focus of this article.

**Option 1**, pay off the HDB loan fully from CPF, entails an opportunity cost of 2.5% interest per annum. Since you remove the money from your CPF to pay off the HDB unit, that sum can no longer earn the default OA interest rate, which is currently 2.5% per annum. This assumes that you do not plan on investing your CPF OA monies in one of the CPF-approved investments.

When you sell that HDB unit, you must then replace the amount taken out, *plus* another 2.5% per year that the money has been taken out. As mentioned, it amounts to an additional 101% for a 30-year period. It must be noted however, that this “interest” is what *would have accrued anyway*, had that amount been left in your CPF OA. In addition, this “interest” is *paid back* into your CPF OA, so ostensibly the money is still yours!

You also have the benefit of not having to worry about servicing a loan or hitting the CPF withdrawal limits. These benefits apply (but on a lesser sum) even if you are already servicing a loan, but have accumulated enough in CPF OA to fully pay off the loan amount ahead of tenor. One caveat though, is that an early repayment penalty may be imposed, so you have to take that into account.

Now let’s look at the alternative, **Option 2,** take a HDB loan. By taking a loan, you can leave a certain amount of money in the CPF OA*, which earns 2.5% interest per annum. (Again, assuming you do not invest the money in other financial vehicles.) But on the flip side, you now have to service a 2.6% per annum loan. This 0.1% difference in interest earned versus interest paid may not seem like much, but it is money that you* do not get back, *unlike the 2.5% per annum “interest” you pay back into your CPF OA.

When you eventually sell the HDB unit, you still must put back whatever was taken out from CPF, including the monthly CPF contributions used to service the loan.

Finally, you also have the worry of making sure the loan repayments can be serviced, even in the event of unexpected crises such as the loss of a job.

Comparing the two options, we can see that paying off the HDB apartment fully has the advantage of not incurring a (small) loss due to difference in interest earned versus interest paid, and more importantly, is more secure against unforeseen loss of earnings. This is valid whether you are buying a new unit, or contemplating to settle a HDB loan early.

But what if your CPF does not have enough to cover the entire amount? In that case, there are two choices available.

**Zero out CPF**

One could totally deplete CPF OA in an attempt to reduce monthly installments to well below the monthly CPF contributions. If this can be done to a degree that the monthly installments are easily covered by savings and cash earnings, then we would probably suggest that you go for it. Again, the assumption here is that you do not have plans to invest in any CPF-approved investments.

However, if the installments still end up being quite high, we would recommend adjusting the loan amount such that there is still a buffer (in the form of liquidable assets*) inside the CPF OA that can keep up loan repayments for 6 to 12 months after loss of a job.

**Equalise monthly installment with monthly CPF contribution**

The other option is to choose a loan quantum that results in a monthly repayment that is just covered by the monthly CPF contribution. In this case, one must ensure that there is still a *significant* amount of liquidable assets* in the CPF OA. This amount should be enough to keep up loan repayments for 12 to 24 months after job loss. In other words, the value of assets left in CPF OA should be 12 to 24 times the resulting monthly installment.

So what kind of loan should one choose? Whether attempting to zero out CPF OA or equalise monthly installments, it really depends on an individual’s risk appetite. For the utterly risk averse, you can go for a HDB loan, which has a high but stable interest rate. For those who like big risk and big reward, then a bank loan with currently super-low rates could be just the thing, but be prepared for future uncertainty. A more balanced approach might come in the form of this new POSB loan for HDB.

Now, there is one more scenario, where you could wipe out your CPF and yet *still* not bring loan repayment amounts to below monthly CPF contribution. That means the price quantum for that HDB is quite large. In that case, we’d advise against living so close to the edge, and shop around for a smaller or less premium model, or for that matter down-sizing or downgrading if you have an existing flat.

At the end of the day, we feel that paying off the loan sooner, or fully paying for the HDB unit in lieu of taking a loan, is the safer and more prudent course of action, especially since public housing is not meant for investment purposes. The amount of money that must be put back into CPF upon sale of the HDB unit is well within the growth potential of even the most pessimistic estimates for HDB units (that is, at least 101% price increase in 30 years). It is then ready for you to purchase your next property, or for you to withdraw from the CPF OA when the time comes, not gone to the bank as is the case with a true loan. Again, we stress that* it is not interest lost!*

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*We realise that there is a rule stating that the CPF OA must be fully emptied before applying for a HDB loan, but there are ways keep a certain amount inside after obtaining the loan.

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