How mortgage equity can help increase CPF Life payouts

Are you thinking of paying down your mortgage with your spare cash, to save on interest costs as your loan instalments ballooned with higher rates?

Think again. You may want to re-channel your funds for better use.

The significant run-up in property prices over the last several years means that if you have been diligently paying down your home loan for some time, you would have reduced the principal sum outstanding quite substantially, while the property valuation has risen.

This means you can now take out more financing, secured against the same property, as the equity portion of the valuation has increased. You will be borrowing from your existing property in the form of a mortgage equity withdrawal loan (MWL), or what is effectively a term loan. You are “withdrawing” from this increased equity over time.

This option paves the way for you to benefit immediately from the national annuity scheme known as CPF Life.

We think of CPF Life as something to research and find out only when we are near 55 years old, which is when our Central Provident Fund savings get swept into the CPF Retirement Account (RA), to be set aside for the CPF Life scheme. The scheme then doles out a monthly payment “for life”, that is, from the retirement age of 65 until death. But there’s a way you can benefit immediately from the scheme.

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Most of us give some kind of monthly allowance to our ageing parents above the age of 65, especially if they have stopped working.

Taking out a term loan to help top up an ageing parent’s RA can give them quite a bit more in monthly payout from their CPF Life, without impact to one’s current cashflow.

Let’s use a fictitious example to illustrate. Suppose John currently services a mortgage of S$800,000 at 3.25 per cent on his private residential property with 20 years tenure remaining. He gives his dad about S$800 every month. His father, born in 1959, will turn 65 in 2024, which is when he will start receiving his payout from CPF Life, estimated to be S$860 on the standard plan based on a current RA balance of S$150,000. (You can estimate the amount of payout using CPF Life Estimator on CPF’s website)

Can you increase this CPF Life payout and is there a cap? The answer is yes.

John can top up his dad’s RA with cash up to the ERS (Enhanced Retirement Sum) for that year, which is set at S$308,700 in 2024. The table below shows the minimum sums which are published by the Board for the five-year period 2023 to 2027.

Using the CPF Life Estimator, John determines that by topping up his dad’s RA with a lump sum of about S$153,000 (hence nearing the cap of S$308,700 in 2024), he could increase his dad’s projected payout from S$860 to S$1,690 – an increase of about S$830.

John decides to cleverly make use of MWL on his existing mortgage by gearing up from S$800,000 to S$953,000, and cashing out a lump sum of S$153,000 for this purpose.

He’s able to do so as he has used little CPF towards the property and this is his only mortgage in Singapore (there are regulatory guidelines on how much you can encash on MWL). Let’s take a look at the impact on his monthly cash flow in terms of mortgage repayment.

Using just the first year’s amortization in 2024 to illustrate, even though John’s monthly repayment goes up by S$867 from S$4,538 to S$5,405, it still makes financial sense to do this.

1. Cash flow perspective

Instead of giving his dad S$800 allowance every month, John pays the bank S$867 more in monthly repayment. Beginning on his 65th birthday in 2024, his dad now gets more or less the same additional S$830 from CPF Life, instead of from his son. In short, there’s no material impact on John’s cash flow every month, even at today’s high interest rate of 3.25 per cent which will not stay elevated forever.

2. Cost perspective

What’s interesting is this – even though there’s no change in John’s monthly cash flow, there are real savings for him now. Not everything he pays is a “sunk cost” like the S$800 he would have given his father previously. The interest component is about half at 48 per cent in the first month, and this is set to go down over time with amortization.

This means his real cost is only about half of S$867, or around S$430 – the interest that he is paying. This is because he gets back the other S$430 in loan reduction over time. His dad still gets the same increased amount of S$830 from CPF Life payout, but John saves half that sum as he’s “paying himself” in terms of reducing the loan. Eventually, he gets back this principal sum when he finally sells the property.

3. Benefit perspective

CPF Life payouts are for life. John’s dad will continue to receive the payout totalling S$1,690 even after John is done paying off his entire loan in 20 years. It does not matter if John changes his plans later and sells his home to buy another more expensive property. For the lump sum of S$153,000 borrowed, he will be servicing an interest component on it that’s much less than giving the whole allowance directly to his dad.

Eventually, John will finish paying off the loan, but the CPF Life payout continues. He also gets back any “unused portion” of the cash value built up upon the demise of his dad, if he has been allocated that with his father’s CPF nomination.

What if the property market turns soft and the value of your property comes down with valuation falling below the outstanding loan, leading to negative equity?

That is a valid concern since the loan-to-value ratio will have increased. But there are stringent guidelines in place that govern how much MWL one could encash. For example, for someone with a single mortgage, typically the total geared-up loan cannot exceed 70 per cent to 75 per cent of the latest valuation, minus the CPF used. In addition, your income must pass the tightened TDSR ratio of 55 per cent before the bank will approve the new higher loan.

The upshot is, not everyone can avail themselves of MWL. So, if you do get it approved, there’s enough margin of safety built in to cater for the scenario of falling property prices.

More debt is not necessarily a bad thing if you know how to deploy it as good debt for either savings or investments.

The writer is the executive director of MortgageWise.sg