Should You Gear Up or Pay Up?

One common question i always received, is "Shall I gear up on my loan or pay up the loan as fast as possible"? The answer depends. Confused? Well, there is really no real right or wrong answer here.... The answer lies with the risk tolerance of an individual and to a certain extent, age too.

First of all, let's break this down into different categories...For those who are in the 20s and 30s, it probably makes sense to take on a greater risk by gearing up, that is, leverage through loans with longer tenure, with the assumption that you have a regular income and/or reasonable amount of savings, investments or businesses that are able to generate some consistent decent returns. These group of people generally can afford to take on more risks and in the worst case scenario, they have something to fall back on.

On the other hand, people who are more than 40s and approaching retirement age may consider taking on lesser risk. Bear in mind that the maximum lending age is generally up to 65 years old. Basically one should make sure that one is able to continue servicing the loan post retirement. Another reason why i like properties such as high-rise apartments or commercial properties that are able to generate positive cash flows. In essence, the monthly rental is more than able to pay off the loan installments so you don't need to worry about it too much!

Overall, you should review your own financial goals, resources (such as savings, investments and other diversifications) and risk appetite in order to come to any conclusion. eg., if you settle your loan first, you may lose out on other investment opportunities that may potentially give you much higher returns than your loan rates. On the other hand, if investment is not your cup of tea or if you have limited knowledge, then early settlement may be the better choice since it is a sure gain. Also bear in mind that all investments come with risk, so you need to be able to bear the risk if your investment decisions turn sour!

Other things to consider include the economy and the likely interest rate direction. Currently i would consider a good time to borrow since the banks are offering very attractive rates to the extent of BLR (Bank Lending Rates) minus 2, which works out to be around 4.75% (assuming BLR = 6.75%). However, in lieu of the current high inflation, banks may raise interest rates going forward. So, you could risk paying more interests in the future! However, i believe the rise should be negligible since the current inflation is cost driven rather than demand.

Another important element is from a tax perspective, it may not be advisable to settle early since there are certain tax benefits that come with investment property such as tax deductibility on loan interests against rental income. Effectively you will be paying less tax on your rental income. If you have two loans for your home and investment respectively, settle the home loan first.

Last but not least, if you have credit card debts (balance transfer and installment plan not included), you may consider refinancing your current property so that you could use the excess funds to pay off the outstanding credit card debts! Like I always said, never ever borrow money through credit card!

Do share with me your thoughts.

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