Looking for ways to save money is not a new concept, but being thrifty was one that was seemingly lost on the current generation for a while.
The typical Aussie household went from saving 15% of its income in the 1970s to none at all in the last five years. However, household savings as a plan is now back on the agenda, according to the latest figures from the Australian Bureau of Statistics (ABS). So, being smart with money is apparently trendy yet again.
An important way of saving money – which is also one of the most effective – is to pay off a mortgage as quickly as possible. The more income put into paying it off sooner, the less the interest costs. To do this, all it takes is careful budgeting and talking to experts, and it can put you on the path to saving thousands – or even tens of thousands – of dollars on your loan.
Saving starts with a budget
A good first step along the path is to review all your options on the loan. There are many ways to save money and pay it off faster, but every borrower has their own unique situation that makes them able – or unable – to do certain things.
Generally, another good place to start is to check your budget, says Tim Buckett, executive general manager of personal customers at Suncorp.
"Looking to reduce your loan starts with budgeting," he says. "We talk about setting a budget and keeping to it."
If you miss a few payments in your budget, like the electricity, gas or water bills that come in only every quarter, you might find yourself in a tough situation, says Buckett. But even smaller amounts matter. He recommends the government site MoneySmart.gov.au as an excellent – and free – way to start planning your budget.
A solid budget plan isn’t the only thing you need to pay off your loan faster, but it’s a good base that helps make all other saving techniques work for you. From there, you have to find as many ways as possible to put as much as you can into your mortgage repayments.
"It's not just one thing that's going to make the difference," says Buckett. “The real trick is a combination of things."
These include setting up an offset account to reduce your loan interest, finding the best loan product and making extra payments when possible. These details add up to quite a lot of money over a period of time – such as a 30-year mortgage. Minimal extra payments spread out over that time become massive.
Make your savings account go further
A common way to save on your mortgage is to pay your salary into an offset account. This is a savings account, but it’s linked to your loan account, and the balance in it is offset against what’s owing on the mortgage.
"People think about paying extra into the loan and having the ability to redraw, but not many are aware of a separate offset account," says Corlett. "This can be a fully functional transaction account, and any monies – such as pay or savings – sitting in it is 100% offset against the loan balance on a daily basis."
An offset account can lead to major savings, says Buckett. Take for example a $200,000 home loan over 30 years with an 8% variable. Considering the borrower has a $60,000 annual salary, amounting to $3,950 per month after tax, putting that amount in an account and keeping an average balance of about $1,000 could slash nearly $10,000 off interest payments and cut the duration of the loan by six months. Maintaining a balance of $2,000 could save as much as $18,000 – and also cut down the length of the loan by more than a year.
Another factor to consider is whether to have an interest rate that’s fixed or variable. The ABS estimates that only 4.6% of total owner-occupied housing finance commitments were fixed rates in August 2008. That’s an all-time low since such records were started by the ABS, back in July 1991.
That shows most borrowers are not expecting interest rates to rise anytime soon. But once they seem to have neared the bottom, fixing can offer a bit of stability for a budget.
"A fixed rate gives people peace of mind, and that's a good outcome in itself," says Buckett.
But he recommends borrowers consider splitting their loan between a fixed and variable rate. How much to balance it at depends on which way the borrower expects the rate to go, he says.
"If you're not really sure where the rates are going to go, splitting it 50:50 is quite acceptable," he says. "Splitting is a good way of hedging your bets."
The advantage of variable rate loan products is that they generally allow the borrower to draw back money when needed. It’s important to secure that flexibility, especially when operating on a tight budget.
"People are generally blown away when you can show them the impact paying, say, an extra $50 per week has on their mortgage," says Lisa Corlett, licensee with Mortgage Solutions Australia.
Using a credit card to manage expenses
It's a risky tactic, but for those with a steady income and good budgeting skills, managing daily expenses with a credit card can come in handy.
Consider a scenario whereby you paid $1,000 per month in bills with your credit card rather than cash, while maintaining a balance of $2,950 in your offset account. As you don't have to pay off your credit card for a month, the offset account balance would in turn increase by $1,000 permanently – and, says Buckett, that additional balance would slash six months off the life of a 30-year mortgage. If the credit card was used to pay $2,000 in expenses, it would save 10 months on the mortgage duration, he adds.
"You can buy pretty much anything with credit cards these days," Buckett says, "and just doing that has a pretty big impact in terms of shortening your loan."
From groceries or petrol to dining out, a credit card can easily reach a balance of $1,000 monthly if it’s used at times when you might otherwise pay cash.
But there's a very important condition regarding this method. For it to work effectively, you must always pay off the credit card debt each month. If you don’t, the interest you are charged would wipe out any benefit of using it, and possibly make your financial situation worse.
"I would recommend caution if choosing this method," says Buckett. "Not everyone is disciplined enough to do it."
Corlett agrees, saying that using credit cards to manage monthly expenses is workable for a minority of borrowers.
"Managing expenses on a credit card is a great opportunity for disciplined householders," she states. "However, in my experience, probably only 35–40% of them are actually disciplined enough."
Switching from monthly to fortnightly
Some brokers call it a myth, whereas others swear it can save you thousands of dollars. So, does it really make a difference to switch from paying monthly to fortnightly?
The answer is yes, but only because it means you pay more annually. You could do exactly the same by increasing your monthly payments.
The way it works is that there are usually 26 fortnights per year, but most people align their budgeting to the idea that there are four weeks in month. Technically, however, in a 365-day year, there are about 4.35 weeks in a month, So, if you cut your monthly payments in loanhalf and pay that amount fortnightly, you essentially pay 13 months per year.
"The only way it benefits repayments is if someone is prepared to halve the monthly amount and pay it on a fortnightly basis," says Corlett.
If a borrower is able to do this, the rewards can be great as Corlett estimates paying an additional month per year can take seven years off a 30-year loan term.
Paying fortnightly might also work for someone who is paid their salary on the same basis. And, aligning payday with your mortgage payments can make budgeting easier too.
That way, as soon as you get paid, the money goes against the mortgage. Then you can’t easily be tempted to spend more than you have – your remaining balance is already set.
In addition to aligning your salary payment with the mortgage, doing some electronically can also make a difference, as it gives you much greater control of how much you repay. You can change this at any time too, while programming automatic deductions to ensure you don’t miss any payments.
What to do when interest rates fall
At the time of writing this, interest rates had already dropped 1.25 percentage points since September, with more rate cuts expected.
Thus, borrowers with a variable rate on their mortgage were reaping the financial benefits, with some gaining hundreds of dollars per month depending on the size of their loan.
But lower interest rates can present homeowners with two options – reduce repayments and consider the rate cut a saving that can be used for more spending, or put the extra cash back into the mortgage to pay it off faster.
Buckett says paying off the loan faster is the better one.
"We always say that if you've got the extra cash, we'd encourage you to pay your loan down," he says. "By not reducing your repayment, you certainly accelerate the term of your loan."
However, for a family just getting by, a $200 bonus each month can be tempting in a period of inflation. Corlett says she can understand both sides – but she, too, recommends keeping repayments the same.
"It is always a great idea to pay as much off of your owner-occupied debt as possible," she says. "If you can afford to keep your repayments the same, even though rates have reduced, it certainly benefits you by taking years off the home loan. But, it might make more sense for some people to use this additional money to pay off any short term debts – like credit cards, which are still charging up around 16%."
All borrowers should measure the value of their debts and savings. And, as you rarely find an interest rate higher than a credit card, it is almost always best to pay off that one first.
When the going gets tough,the tough get going
The confidence of both financial institutions and the borrowers who rely on them has dropped, in Australia and globally.
However, as many house prices have levelled out or gone down, and interest rates are also lower, it could be a time of opportunity for those with the means to buy more property. The market is saturated with sellers in assets such as real estate and shares, as many have panicked and tried to escape a situation they fear can only get worse. Others need to get out for other reasons, but – either way – prices are down.
Few people are borrowing lately. According to the ABS, August 2008 had the lowest number of home loan commitments since March 2001, while the average loan size is also dropping.
"It is in times like these that you can benefit from going against the crowd," says Corlett. "Obviously you need to be in a position of solidarity to be able to go against the flow, but those who have the appetite and the where-with-all to do it can take advantage of the opportunities that a downturn in markets provides."
Not everyone has that luxury, however, as these are mostly people who desperately needed the rate cuts and are still struggling to get by.
"For those less fortunate who can't afford to do much except batten down the hatches, this is a time to work critically on not running up short-term debt," says Corlett. "Learn to go without, don’t use credit cards or fall for offers of ‘buy now and no repayments for 12 months'. We need to start thinking like our parents did, and say to ourselves, 'If I can't pay cash for it now – I can't have it'. And, for those who have credit card debt, just make repaying it your top priority."
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