This question has baffled me for quite a long time. When you use your CPF money to service your housing loan, CPF will compute accrued interest on the amount you withdraw from CPF until you sell the house. The accrued interest reflects the amount of interest you would get in your CPF account had you not used it to service the loan. When you sell the house, the principal and accrued interest have to be returned to CPF. This raises several other related questions – should accrued interest affects the attractiveness of the housing purchase and is better to use CPF or cash to service the housing loan?
To better appreciate and answer these questions, it is best to consider a typical scenario and leave CPF out of the picture for the time being. Let us assume that you intend to purchase a HDB flat for $500K. HDB agrees to loan you 90% of the purchase price. You will need to fork out the remaining 10% as downpayment. However, your kind-hearted parents, who have been working for several years and have accumulated some savings, willingly offer to pay the downpayment for you. You relunctantly agree, promising to pay them interest for the money loaned so that they could have sufficient money for their retirement. Thus, HDB pays 90% of the purchase price while your kind-hearted parents fork out the remaining 10% and you do not need to pay a single cent.
The HDB loan is a formal loan which requires monthly repayment, whereas the loan from your parents is an informal one which does not have any fixed payment terms, except for your promise to return the full amount borrowed plus accrued interest to them when you sell the house. Each month, you have to make repayment to HDB to pay down the formal loan. Again, your kind-hearted parents offer to service the monthly repayment so that you do not need to fork out a single cent every month. Thus, over time, as you pay down the HDB formal loan, you borrow more and more informal loan from your parents, with accrued interest growing increasingly with time and size of the informal loan. When you have fully paid off the HDB formal loan, you no longer need to borrow additional money from your parents, but the accrued interest continues to accumulate, until you sell off your house.
Assume further that you sell off the house for $1 million and the principal borrowed from your parents plus accrued interest amounts to $800K. As promised, you return $800K to your parents and retain the remaining $200K. Your kind-hearted parents accept the money, but assure you that whatever money they have will eventually belong to you as inheritance. Thus, it does not really matter whether you return $800K or $600K to them, because you will eventually get the full $1 million.
Now, kind-hearted parents tend to have kind-hearted children. Assume that you decide to use a generous interest rate to compute the accrued interest such that the principal plus accrued interest amounts to $1.2 million. As this exceeds the sales proceeds from the house, you will return the full $1 million to your parents and get nothing. Your parents do not require you to cough up the remaining $200K owed to them. From your perspective, this looks like a "lousy" investment as you end up losing $200K on the housing purchase. However, can this really be considered a lousy investment, since the house doubles in value from $500K to $1 million? The computation of accrued interest merely affects how the sales proceeds are distributed to your parents and yourself. Considering that you will eventually get back the full $1 million, the accrued interest does not affect the attractiveness of the housing purchase.
Now, let us suppose from the beginning that you actually have some cash and do not need to rely on your parents' savings to service the downpayment and/or monthly repayment. Which of these would be a better option to service the loan – using your cash or your parents' savings? It all depends on who can grow the money at a higher rate. If you are able to invest your cash at a higher rate of return than your parents, then it is better to use your parents' savings to service the loan. Conversely, if your cash is left in the bank earning 0.05% interest rate while your parents' savings are able to grow at 2.5% annually, then it is better to use your cash to service the loan.
We have come to the end of the story. Now, please replace the kind-hearted parents in the story above with your own CPF savings. It becomes a whole lot clearer what the CPF accrued interest is all about and whether it affects the investment and financing decisions. To summarise,
- CPF accrued interest arises because you are taking out a second, informal loan from your CPF account to service the downpayment and/or monthly repayment so that you do not need to draw down your cash. It is not double counting of interest on your formal housing loan.
- Computation of CPF accrued interest and return of principal plus accrued interest after the sale of the house merely affects the distribution of the sales proceeds between your CPF account and yourself. It does not affect the attractiveness of the housing purchase. The key interest rate that affects the investment decision is the housing loan interest rate, not the CPF interest rate used to compute the accrued interest.
- Whether to use CPF or cash to service the housing loan depends on their relative rates of return. Use the one with the lower rate of return to service the loan.
By the way, topping up your and/or your family members' CPF accounts with cash allow you to enjoy income tax reliefs of up to $7,000 (top-up for yourself) + $7,000 (top-up for family members) next year. If you have not done so, please hurry, before the year ends!
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