CPF And Accrued Interest

Have you been using too much of your CPF for your HDB flat? Yes, I believe most home owners are, but what are the consequences? Let’s understand a little more on CPF first.

In Singapore, companies have stopped paying pensions to their employees upon retirement, and the government has started CPF fund as a form of retirement fund for the citizen, and I guess no one is a stranger to that. The CPF Ordinary Account pays a 2.5% interest rate to the citizens, which compounds on a yearly basis, and honestly, this is quite a good deal for most Singaporeans if you are not versed in investing your own money. The power of compounding interest is definitely one of the wonders of the world if you know how to use it, but it can also be a sharp knife to kill you if its working against you.

Even as CPF fund is primarily planned as a retirement fund for each individual, the truth is that almost all Singaporean will need to use it at one point of their life to buy a home. Do you know the consequences of using this fund and how it will affect you in the long run?

Let’s understand a little more on how the CPF fund is being allocated:

CPF-Contribution-Rate
CPF-Contribution-Allocation-Rate

Let’s us look at a case study:

Case Study 1

Stanley and Lucia, both age 30, bought a BTO at $350,000 in Sembawang area.

They are both graduate, and have been working at the age of 25. Assuming that their salary to be constant at $4,000 for the 5 years, with no bonus. They will wipe out the entire COF OA balance for the downpayment of the BTO, and will not be taking any government grant.  As they want to become debt free early, they choose to take a 10 year loan.

Note: As of 28 August 2018, HDB flat buyers have the option to leave up to $20,000 in the CPF Ordinary Account ($20,00 combined for both parties) when taking an HDB Loan. 

 

The below will be their CPF OA contribution:

AgeCPF OA Contribution Per YearInterest Earned On the OA @ 2.5%CPF OA Balance
25$22,080$298$22,378
26$22,080$1,155$45,315
27$22,080$2,586$68,826
28$22,080$4,604$92,924
29$22,080$7,225$117,625
30$22,080$10,464$142,944

Summary:

BTO Purchase Price = $350,000

Downpayment = $142,944

Loan Amount = Purchase Price – CPF OA Balance
                          = $207,056

Loan Tenure = 10 years

Government Grant = $0

Monthly Installment = $1,961

AgeLoan Tenure YearCPF Principal Used (Downpayment + Monthly Installment)Accrued InterestOutstanding LoanBreak-even Price To Sell Without Cash Proceed
311$166,476$3,891$188,685Can’t Sell Within MOP
322$190,008$8,468$169,832Can’t Sell Within MOP
333$213,540$13,747$150,482Can’t Sell Within MOP
344$237,072$19,747$130,623Can’t Sell Within MOP
355$260,604$26,485$110,241Can’t Sell Within MOP
366$284,136$33,979$89,323$407,438
377$307,668$42,250$67,855$417,773
388$331,200$51,315$45,821$428,336
399$354,732$61,195$23,209$439,136
4010$378,264$71,911$0$450,175
45Loan Fully Paid$378,264$131,068$0$509,332
50Loan Fully Paid$378,264$197,998$0$576,262
55Loan Fully Paid$378,264$273,724$0$651,988
60Loan Fully Paid$378,264$359,401$0$737,665
65Loan Fully Paid$378,264$456,336$0$834,600

Stanley and Lucia’s loan was fully repaid when they are 40, and for the amount that they have utilized from their CPF OA account, they will need to pay Accrued Interest of 2.5% . In lay man term, they are paying interest on their own money. If they have not used the money in the CPF OA account, they could have earned 2.5% interest being paid by CPF Board, but once they used the CPF OA fund to pay for their BTO, they will need to pay 2.5% accrued interest back to their own CPF OA account once they sold the HDB. Hence, when they use the money in CPF OA.

Accrued Interest To Be Paid on CPF OA Fund Used To Pay For HDB = 2.5%

Interest That They Forgo Earning If The Money Is Still In CPF OA = 2.5%

THEY ARE LOSING 5% INTEREST ALTOGETHER!

In over a period of 10 years, they have chalked up $71,911 in Accrued Interest that needs to be paid back into CPF OA. If they are to sell at this period, they will have to sell at $450,175 just to break-even with no Cash Proceed.

 Stanley and Lucia is happy that they have paid off the loan at age 40, as they thought they have achieved “Financial Freedom” with no debt, and with a roof over their head. They intend to stay in their BTO till they retire at the age of 65, and sell it to downgrade to a smaller flat at that time.

Big mistake for them, as they did not expect that for the amount of CPF OA they have used to buy the BTO, the Accrued Interest continues to be charged even though they have fully paid their loan. The scary part is that the Accrued Interest is charged on the total CPF amount used and also on the interest accumulated over the 10 years period at a COMPOUNDING RATE OF 2.5% per annum!

Age 40 CPF + Accrued Interest = $450,175 

Compounding Interest of 2.5% for $450,175 will start from the age 41 to 65, for 25 years!

At the age of 65, the CPF + Accrued Interest has compounded to a staggering $834,600, in which the Accrued Interest is more than the CPF Principal being used! $834,600 will be the amount that they will need to sell in order just to break-even with no Cash Proceed, and the property only has remaining lease of 64 years, do you think it is able to sell at that price? If the selling price is lower than the break-even price of $834,600, then it will constitute a Negative Sale.

Let’s have a look at the article below from Today, that talks about HDB flat with short lease remaining. You can read from this link too:

https://www.todayonline.com/commentary/what-happens-when-hdb-flats-short-leases-left-are-no-longer-assets

HDB-With-Short-Lease-1

Just to quote a few lines from the articles above to highlight the negative impact of short remaining lease of HDB:

“Based on a large sample of public resale flat transactions from 1997 to 2017, and after controlling for the quality of transacted resale flats – such as the flat attributes (unit area and floor height), and other spatial attributes (distance to schools and MRT stations) – I find a significant negative relationship between HDB resale prices and age.”

“With buyers not able to use their CPF monies to pay for these older flats, the value of flats with very short leases will decline.”

“As their leases continue to shorten, potential buyers will have to price in the risk of lease expiry driving a faster depreciation in values.”

“Going forward, owners will have to be prepared to accept lower prices for older flats as their leases become shorter.”

“In short, buyers and sellers of HDB flats should come to term with the changing reality that flat values may not always continue to rise with time, and the government would also not always be there to “bail out” their ageing flats through SERS.”

Accrued Interest Is Still My Own Money

I get this very often: “Ethan, why do I need to care so much since the Accrued Interest goes back to my CPF account, it is essentially my own money, so it doesn’t matter even if it’s compounded to a high amount”

This is a very dangerous thinking because they have failed to realize that if the Accrued Interest portion can’t be covered for by the sale price of the HDB, they have effectively lost this amount of money that they should have earned in the first place. Does it sound confusing? Taking the figure from the above table:

Stanley and Lucia sell their HDB at age 65,:

Remain lease of HDB = 64 years

CPF + Accrued Interest = $834,600

Outstanding Loan = $0

Sale Price = $650,00

Cash Proceed = Sale Price – Outstanding Loan – CPF Principal – Accrued Interest

= $650,000 – $0 – $834,600

= – $184,600

Due to the remaining lease of the their unit, they only managed to sell it at $650,000, and therefore it is a Negative Sale. The shortfall of $184,600 in Accrued Interest is a loss to them, as they have lost their own CPF fund due to negative sale. This amount would not have been lost if they have sold off their unit at the earlier stage when the Accrued Interest is still low and the remaining lease of the HDB is still relatively long, as they will most likely be able to sell it higher than the break-even price.

In summary, they have lost not just $186,600, but also the compounding interest that they could have earned if the fund have been left in CPF OA account, and also the Cash Proceed if the sale is a “Positive Sale”.

Do We Stop Using CPF To Pay For Our Property Then?

Don’t get me wrong, I do not mean to tell you to stop using CPF to buy property. For most Singaporean, it is almost impossible to kick start their dream of owning a house of their own if they can’t use CPF to pay for their purchase. CPF is a wonderful tool that we can’t do without for the purpose of buying a house, but that does not mean we can utilize it indiscriminately. Learn the right way on how to utilize your CPF today, and you will realize just how important and how big an impact it can have in your retirement year.

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