FREE MALAYSIA TODAY. 26TH MARCH: It is a given that one should aim to pay off one’s housing mortgages as soon as possible. However, there is one exception to this rule, which can be illustrated as follows.
When Richard was 25, he bought an apartment for RM80,000. Today, the same unit is valued at RM150,000.
He has an outstanding mortgage of about RM40,000 on the property, and collects RM700 a month in rental income.
When he was 29, he bought a second residential unit, a condo, for RM350,000. Today, it has the same value, and his outstanding mortgage is RM300,000. He currently resides in this property.
Now, Richard intends to buy a terrace house for RM700,000. He wishes to live in it and, thus, will be renting out the second condo unit.
Richard has RM300,000 in his bank balances. What, then, is the best way for him to finance his purchase of property No. 3?
As Richard has outstanding mortgages on two residential properties, he would be required to place a 30% down payment on property No. 3, which would work out to be RM210,000.
Factoring in approximately RM35,000 in transaction costs, which is 5% of the purchase price, Richard’s total capital outlay would be RM245,000. In his case, he would be left with RM55,000 in his bank accounts.
Instead, he could do the following:
Step one
Richard could settle his outstanding mortgage of RM40,000 for property No. 1, which would reduce his number of mortgages from two to one. Also, his bank balances would reduce from RM300,000 to RM260,000.
Step two
After settling the mortgage for the first property in full, Richard is now eligible to buy the third property with a 90% mortgage, which requires him to only put down 10% in down payment, instead of 30%.
Why is this possible? Because property buyers are eligible to borrow up to 90% of a property price for two residential properties.
Since Richard has paid off his first, the mortgage for property No. 3 would be viewed as mortgage No. 2.
Hence, instead of RM210,000 in down payment, Richard’s down payment would work out to be RM70,000.
Adding RM35,000 in transaction costs, Richard’s total capital outlay would amount to RM105,000, leaving him with RM155,000 in his bank accounts – RM100,000 more than he would have if he didn’t pay off the mortgage on property No. 1.
Step three
Now, this is optional for Richard. After step one, Richard would own a fully paid apartment worth RM150,000. He could go to his banker and refinance the property.
As this would be mortgage No. 3, the maximum amount he could qualify for is 70% of the property’s value, which is RM105,000.
Factoring in a RM5,000 cost for a Mortgage Reducing Term Agreement (MRTA), the installment would be RM423 a month for a 35-year loan at 3% interest rate.
This is lower than his rental income of RM700 a month and, as such, the RM105,000 from this third mortgage is essentially “free money”, leaving him with RM260,000 in the bank instead of RM155,000.
This places him in a better financial position as he has more cash at his disposal, which he could use either as a buffer or reinvest to grow his wealth even further.
This is the only exception to paying off one’s mortgages as soon as possible.
