Buying Cash or Taking Loan

Sumber:http://fortunesense.blogspot.com/2008/10/buying-cash-or-taking-loan.html
Imagine if you have cash to buy a property, will you buy it by cash or you will buy it using the banking property loan facility ?

Example: If you have RM 200000 cash on hand and is able to generate 4% return rate yearly, after 20 years you will have RM 438224.66.

If you take a loan with RM 200000 and loan interest rate is
- 7%, after 20 years the total payment is 372143.49,
- 8%, after 20 years the total payment is 401491.23
- 9%, after 20 years the total payment is 431868.46

From the calculation, it seems that it is wiser to put your cash in the investment tool that can generate 4% if your loan interest is 9% and below.

Updated section:

Part of the reader's comment,

If i have RM 200k Cash earning 4% a year, and i have to pay monthly installment of RM 1,550.60 for 20 years for my housing loan (which charges me 7% interest a year), how much will i have afte 20 years?
What if my monthly installment is RM 1672.88 instead (at 8% rate, 20 years) ?

Lastly, what if my monthly installment is RM 1,799.45 instead (at 9% rate, 20 years) ?

The answer for all 3 questions above, is that your money won't even last for 20 years!. Meaning, once your lump sum finishes, you still owe money to the bank!.

Conclusion: You'll be better off paying off the bank if your investment rate is lesser than the interest charged by your loan. Simple as that!.


COMMENTS

U Lian // June 20, 2009 10:00 AM
Is the amt of return of 4% taken into consideration of inflation? What is the actual value of the money after 20 years?

Fortune Sense // June 20, 2009 12:54 PM
The 4 percent return rate does not consider the inflation rate but the total amount of investment after 20 years do consider the compound interest factor.

For both the total amount of investment and the total payment to the bank in this calculation do not take into the inflation factor.

The conclusion is judged by the face value after 20 years.

Do share your opinion on this.

cheongpeng // August 19, 2009 7:22 PM
The calculation is just theoretical. In practical, when purchasing property, u need to pay lawyer fees, stamp duty, maintenance fees, repair fees and others. This is just a rough guide.

For the example, the interest u earn if put in 4% investment is used to pay for bank interest. So...u r still the same. Unless the property increase in value. What happen if u made the wrong decision?

Fortune Sense // August 19, 2009 11:07 PM
Thanks for the input.

The calculation method is based on the assumption that the interest earned is being reinvested back into the investment that can generate the same 4% interest.

If the property value decrease or increase at the end of the loan period, the total payment at the end and the total investment value should be still the same as the amount being calculated.

Welcome to share your opinion on this.

Peter Lim Cheng Teik and Tan Shu-Yin // October 23, 2009 1:28 AM
I disagree with the calculation. When you take a loan, you have to pay monthly installments.

The monthly installments that you paid lost its opportunity to earn interest.

Thus, when you use a comparison of "total" interest you paid over a certain period of time, you're assuming that there's no opportunity cost during this period.

Infact, whether cash or loan is better simply depends on your inveestment return vs the interest charged. If your investment return is 4%, and loan is charging you 9%, then you're better to pay off the loan.

Fortune Sense // October 24, 2009 1:23 AM
Hi Peter and Shu Yin

The calculation does not include the "opportunity cost" investment return rate :P.

It is good if a person is determined and self disciplined to invest consistently the amount as the housing loan installment amount into an investment product that can generate positive return rate for the housing loan period.

Another perspective is that with the cash on hand (example 200K in this case), when the "opportunity" comes the money could be invested into it in order to generate a better return rate.

Hopefully by knowing the risks associated with the strategy that we use and understanding what we are doing, it will minimize the probability of losing and increase the probability of winning in the investment strategy plan.

Welcome to share your opinion on this.

Peter Lim Cheng Teik and Tan Shu-Yin // October 27, 2009 12:19 AM
Let's make a fairer comparison by assuming that the person does not use other "savings" to pay for his monthly installments, since i'm sure nobody is so dumb not to earn interest with their money.

If that person pays cash for his purchase, he won't have a monthly installment. Fullstop!

However, if that person takes 200k loan, he have to pay monthly installment. Although he have RM 200k CASH in hand, how about the installments?.

Let's be fair, in this case, and assume that he withdraws his "lump sum" of RM 200k to pay for his installments monthly.

The loan interest at 7% (yearly) translates to an interest payment of RM 1,167 on the 1st month. However, the interest you earned on your RM 200k at 4%, is only RM 667 on the 1st month!. That translates to a deficit. As time goes by, the deficit will be more.

Of course, you could assume that the person have "money" elsewhere to pay for the monthly installments (thus leaving the RM 200k intact to earn 4% compounding). If that is so, we could also do some funny assumption, like:

Take RM 200k loan, for 1 year, at 100% interest (super Ah Long). With this assumption, the total payment is only RM 323,989.85.

This being the case, does it mean that the above loan is better than 7% for 20 years?.

If it is so, let's get "funnier" again.

This time, we'll take RM 200k loan, for 200 years, at 1% interest per year.

With such loan, the total payment (over 200 years) is RM 462,667.40, which is the more "expensive" than the above 100% interest at 1 year, or even 9% interest at 20 years.

Obviously something is flawed, which is "Time Value of Money".

Yet your calculation never factor in opportunity cost, which will lead this kind of "funny" decision making.

Fortune Sense // October 27, 2009 7:25 PM
Hi Peter and Shu Yin

Thanks for the input.

The calculation does not include the "opportunity cost" investment return rate :P.

The calculation method will be different if take into the consideration of the interest earned when use the monthly installment amount to invest.

Do take into the factors (time value of money, opportunity cost, consistent investment method, positive retun rate, risks and etc) that are relevant to the individual while making the decision in order for him/her to have the most benefit.

Happy Investing.

Peter Lim Cheng Teik and Tan Shu-Yin // October 27, 2009 11:46 PM
I think a better comparison is this:

If i have RM 200k Cash earning 4% a year, and i have to pay monthly installment of RM 1,550.60 for 20 years for my housing loan (which charges me 7% interest a year), how much will i have afte 20 years?

What if my monthly installment is RM 1672.88 instead (at 8% rate, 20 years) ?

Lastly, what if my monthly installment is RM 1,799.45 instead (at 9% rate, 20 years) ?

The answer for all 3 questions above, is that your money won't even last for 20 years!. Meaning, once your lump sum finishes, you still owe money to the bank!.

Conclusion: You'll be better off paying off the bank if your investment rate is lesser than the interest charged by your loan. Simple as that!.

People who knows a bit, try to complicate matters to the public. People who knows a lot, try to simplify the complicate stuff. Housing loan vs investment return is as simple as it can get.

I would appreciate if the matter is not to confuse or misleading people.

I believe many people read your blog, and from your "article", people might get a misleading conclusion.

While i truly advocate taking housing loan instead of paying cash, i'm very clear of the reason (which is OBVIOUSLY my investment return is better than the housing loan rate, by a wide margin!).

Fortune Sense // October 28, 2009 8:38 PM
Thanks for the input. :P

Agreed with investment return rate needs to be higher than the loan rate and keep it simple.

Glad to know that your investment return is better than the housing loan rate and by a wide margin.

Wish you achieved your financial goal as soon as possible. :P

Happy Investing!