Mortgage: Is a housing loan a good debt or bad debt?

June 2, 2022 June 2, 2022

Are you searching for a bank for your home loan, the SORA interest rate benchmark or a housing loan calculator to work out your sums?

Perhaps a more fundamental question needs to be addressed first: Is a housing loan a good debt or bad debt?

Adrian Jefferson, a veteran in the mortgage industry with over 16 years of experience who has personally served three billionaires and more than 4,500 individuals and companies on their mortgage portfolios, shares his insights.

Having a long-term debt is not something everyone is open to. Especially one as huge as a mortgage loan.

However, not all debts are bad. Let’s start by defining what’s good debt and bad debt.

What is a good debt?

A good debt essentially means borrowing money to pay for things that can potentially help you enhance your value, build wealth or increase your income in the future.

What is a bad debt?

On the other hand, a bad debt involves borrowing money to purchase rapidly depreciating assets or only for the purpose of consumption. Therefore, it generally causes your financial situation to be unstable and creates uncertainty.

So, should a housing loan be considered good or bad debt? Let’s find out.

Buying a property would probably be our biggest ticket item. Having a mortgage loan would probably be the biggest debt commitment we embark on.

Housing loan as a good debt

1) Asset

Whether the property purchase is a home to live in or an investment property to earn rental income, your mortgage loan is essentially helping you buy into an asset class.

An asset class that has historically increased in value over the long term.

2) Creating equity

Every monthly repayment you make on your loan creates equity in your home as you pay down the principal.

Equity is the difference between the current value of your home and how much you owe on it. It may be a useful tool that can be leveraged to build further wealth.

As you continue to make repayment over the years, the value of your house goes up while your outstanding loan comes down. The difference is a buffer that can be withdrawn as an equity loan to accelerate your financial freedom should suitable investment opportunities present themselves.

3) Comparatively lower borrowing costs

Housing loan interest rates are generally considered low compared to other kinds of borrowing costs.

Hence, this makes it an efficient way to leverage the comparatively lower housing loan interest rates to pay off other higher interest charging debts. For example, business loans, construction loans, credit card debts and overdraft facilities.

Housing loan as a bad debt

Now, let’s consider the circumstances in which a housing loan may be viewed as a bad debt?

1) Over-leverage

Although mortgage loan interest rates are comparatively low in general, we do see some property owners “bite off more than they can chew”.

They take up more mortgage loans than they could be over-stretching to fulfil their monthly mortgage obligations. This may result in the property being foreclosed when default happens.

2) Margin Call

This happens when the market value of your property drops below or to the outstanding loan owing to the bank, you may be asked to top up the difference by paying down your outstanding loan.

Although in Singapore’s context, the chance of a margin call is slim if you diligently fulfil your monthly mortgage payment.

3) Purpose and usage of equity loan

Earlier, we mentioned using equity loan to accelerate your financial freedom.

The reverse can also happen when the equity loan is not well deployed, such as on things for self-consumption and things that depreciate in value.

Typically, the purpose of the equity loan should be for reinvestment to grow the capital of the equity loan at a higher rate than the mortgage interest charged.

Good debt or bad debt?

In conclusion, whether you define a mortgage loan as good debt or bad debt depends on how you work around the budget and purpose of your property purchase.

It is essential to begin this buying process by having an open discussion with your trusted financial adviser to consider what you can afford and what compromises you will have to make.