You will be able to compare paying a loan early with saving or investing the same money.
Arjun's year-end bonus comes in at S$2,000 after CPF. One colleague tells him to throw it at his study loan: debt is bad, clear it. Another tells him that is a waste, because a loan at 4.5% is cheap and markets have done better than that over long periods. Both sound confident. Neither knows anything about Arjun's situation.
The question is a real one, and the answer depends on four things you can check. This lesson goes through them in order. The figures are made-up examples, and nothing here recommends a product.
When you pay extra off a loan, you stop paying interest on that amount for the rest of the loan. So every dollar you repay early earns you the loan's interest rate, with certainty. There is no market risk and no chance of it going wrong. If your loan charges 4.5% a year, paying it down early is like getting 4.5% a year on that money, guaranteed.
Here is what that looks like for Arjun, using the loan from lesson 5.1, Bank study loans and the CPF Education Scheme compared: S$20,000 at 4.5% a year over five years, about S$372.86 a month. Over the full term he would pay about S$2,371.62 in interest. If he puts his S$2,000 bonus into the loan at the end of month 12 and keeps paying the same monthly amount, he finishes in 54 months instead of 60 and pays about S$2,002.08 in interest. The extra S$2,000 saves him about S$369.54 and six months of repayments.
Investing the same S$2,000 has a different shape. Over a long period it might earn more than 4.5% a year, or less, and in any one year it could fall. Lesson 5.1 of How money works, Every place you put money trades risk, return and liquidity, covers this trade. The loan side of the comparison is certain. The investing side is not. So the question is never just which number is bigger. It is whether an uncertain return beats a certain one, for money you might need.
Before paying any loan early, look at your emergency fund from lesson 4.3, A buffer first: an emergency fund sized to your life.
Money you pay into a loan is very hard to get back. If you lose your job a month after making an extra payment, the lender will not return it, and your monthly repayment usually stays the same. You would have a smaller loan and no cash, which is the worst combination in an emergency.
So the order is buffer first, then extra repayments. Arjun has almost no buffer, which his laptop showed in March. For him, the S$2,000 goes into the emergency fund first, whatever the loan rate.
Some loans charge a fee for early or partial repayment, or set rules on how often and how much extra you can pay. A fee reduces what you save, and a large one can wipe out the benefit. Read the early repayment clause in your loan agreement, or ask the lender. For the CPF Education Scheme, check the CPF Board website for how extra payments work.
The higher the rate, the stronger the case for paying early. A loan charging a high rate is expensive to keep, and almost nothing you could do with the money earns that much with certainty. A loan at a low rate is cheap to keep, and the case for paying it early rests more on peace of mind than on maths. Arjun's 4.5% sits in between, which is why his colleagues disagree.
Make sure you are comparing the right rates. If your loan quotes a flat rate rather than an effective one, lesson 3.2 of How money works, Why a flat rate loan costs nearly double what it looks like, shows why the real cost may be higher than it looks.
The last check is not about maths. Lesson 5.2 showed that CPF Education Scheme repayments go back into the account the money came from, often a parent's. For Hui Min, paying faster refills her mother's retirement savings sooner. That can be worth doing even when the interest saved is small, because the benefit lands on someone she cares about at a time when it matters to them.
None of these checks has a single right answer. What they give you is a decision you can explain: here is my rate, here is the fee, here is my buffer, and here is why I chose to pay early or not. Arjun's version is short. Buffer first, then next year's bonus goes to the loan.
Write down your loan rate, any early repayment fee and your buffer status, then state whether you will pay early and why.
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