Wednesday, April 18, 2012

When to make early mortgage repayments

All our Hong Kong properties are mortgaged and will remain so when I retire. Given current market conditions, it makes no sense whatsoever to make early repayments on any of the outstanding mortgages:
  • interest rates on the mortgages are currently averaging less than 1.0%
  • interest expenses are tax deductible
  • inflation is still above 4%
  • there is no shortage of good shares with yields well above 1.0%
  • the rental properties produce a positive cash flow after all expenses including the principal component of the mortgage payments
  • if I had to borrow today, I would probably end up paying 2.15-2.4%
There simply isn't a case for making voluntary repayments.

However, the interest rates are HIBOR based floating rates - they get reset either every month or every three months. If HIBOR rises then the interest rate I am paying on my mortgages will also rise.  The question is, at what point should I start making additional repayments?

Without wishing to over analyse the situation, I would start making additional repayments if any of the following applied:
  • interest rates were higher than the rate of inflation
  • the investment properties were producing a negative cash flow
  • interest rates were higher than the yield on other available investments
In each case, it would also be necessary for me to believe that the situation would continue for some time and was not a short term issue.

It also helps that all of the mortgages are P+I - each month the balance gets a little smaller even without any additional payments and, as the balances get smaller, the impact of rising interest rates becomes less significant.


Anonymous said...

I don't particularly disagree with you but sometimes it is good to consider from a different perspective so I will argue!

You are looking at it from a reward point of view but the real case for paying down your loans would be to reduce future risk.

When you retire, your main financial risks will be inflation, medical bills, divorce, crash in portfolio value, and inability to service your debts. Some of these may be very unlikely but who knows.

Take medical bills, you try to reduce this risk by buying medical insurance. This is money used to reduce risk. It is not expected to give you a positive return.

In housing, there is a risk (probably low but non-zero) that rents will plummet and interest rates will soar causing you cash flow problems. Early repayment could be considered as a way to reduce this risk.

Anonymous said...

Part 2...

I know you are not even remotely close to being this daft but when people are told to invest rather than paying off capital things like this tend to happen.

traineeinvestor said...


Thanks for the detailed comments. You are absolutely right in that I am largely focused on the reward part of the equation and am assuming more risk by keeping the mortgages. The points you raise merit a more detailed response, so I'll do a further post or two on this subject.