“There are only two ways you can pay off your loan quicker. First, pay more than the minimum repayment, and second, get the lowest interest rate you can”
“If the loan does have a feature like an offset account at no extra cost, that’s well and good, but if it’s going to cost extra, then is it really worth it?”
Break up the word mortgage into its two French components and you’ll make the disconcerting discovery that Mort means death and Gage means pledge. So your mortgage is actually a ‘death pledge’. Great. But need the process of committing to a home loan literally be a commitment for life?
Brad Oliver, director, First Choice Home Loans, says: “In reality, there are only two ways you can pay off your loan quicker. First, pay more than the minimum repayment, and second, get the lowest interest rate you can.”
While admitting that special loan features and tools can help the process, ultimately Oliver feels it comes down to the actions of the borrower. “Products like 100% offset and line of credit are useful tools that will facilitate the process,” he says. “But at the end of the day, it’s still up to the borrower. Having a 100% offset or line of credit will not make it happen on its own – it needs to be driven by the borrower, and driven well!”
Oliver also disregards ‘quick fix’ solutions: “Beware of so called debt reduction companies that charge a fortune to set you up into a line of credit with the promise of repaying your loan early without making extra repayments. This is just not true!” he says.
“You don’t need to pay these companies the thousands of dollars they charge. Just get the right product and stick to your budget.”
Maximise your deposit
It may seem the most obvious thing to do, but maximising the amount of your deposit has clear benefits. A larger deposit will reduce your loan to value ratio (LVR) as you’ll be borrowing less money for the principal. You should also be able to take advantage of lower interest rate loans and adjust the term of your loan to suit your needs.
The risk that the lender may lose money increases as the LVR rises. When the LVR rises above 80% (ie when your deposit is less than 20% of the purchase price) most lenders will require extra protection against the likelihood of your defaulting on the loan. The cost of that protection is passed onto the borrower in the form of lender’s mortgage insurance (LMI). This is a one-off, up-front payment. The cost is based on a sliding scale based on the percentage of the property value you borrow. On average, LMI can cost 1.2-2.0% of the loan value, although for some loan types such as 100% (no deposit) loans, this can escalate to as much as 3%.
Pay a lump sum
Provided there are no penalty rates imposed by your lender for making lump sum or extra repayments, pumping more money into your mortgage will pay dividends. The principal amount on which interest is calculated will come down, thus you’ll pay less interest overall.
Of course, it’s not hard to think of situations where you might come across a bit of extra income. Think of tax returns or Christmas bonuses. Redraw facilities available on most standard variable loans allow you to take back extra payments if required. This can come in handy when saving for something significant. “Rather than use a bank account, if your loan allows, pay the extra savings directly into your mortgage,” says Joshua Axford, director, Compass Finance. “Then when the time comes to make the payment for the item being saved for, at least you’ve actually reduced the principal during that period.”
“The only way to pay off your mortgage faster is to actually put more money into it,” Axford says. “If you’re currently paying monthly try to pay weekly. That’s far more effective because you’re paying off the mortgage principal sooner and therefore there’s less interest to pay.”
There are two fundamental reasons why weekly or fortnightly loan repayments are better than monthly. Firstly, interest on loan accounts is calculated on the daily balance, so you’ll benefit from having the balance reduced more frequently.
Secondly, there are more than two fortnights or four weeks in every month, so paying fortnightly or weekly actually means you’ll make more payments per year: 26 fortnightly payments or 52 weekly payments, not 24 or 48 as there would be if all months were exactly 4 weeks long.
People employed in certain professions (engineers, medical practitioner, solicitor, etc) or those earning more than $50,000 a year or $80,000-plus with a partner may want to consider a professional package. These charge interest up to 0.7% lower than standard variable loan rate for the life of the loan. Pro-packs will also combine all the fees into one annual payment. Other components of a pro-pack can include fee-free transaction on credit card accounts, discount insurance, and financial advice. This is to induce borrowers to consolidate a range of products with the one institution.
However, make sure these added services are worth your while, especially as you’ll pay around $300 per year in fees. Your lender can show you how long it will take for interest savings to cover the annual fee. Most pro-packs are also only available on loans with all the bells and whistles – so you’ll need to ask yourself if you really need to pay for them.
Show some interest
As a home loan is likely to be the biggest financial undertaking of your life, show some interest in the economy. Shop around prior to taking out your loan to get the best interest rates for the loan that covers your needs. Alternatively, use a broker to do the legwork for you. Keep a close eye on interest rate moves and heed the advice of experts when choosing a fixed or variable loan – but also keep in mind that predicting interest rate movements is rather like picking winning lotto numbers.
For a fixed rate loan, you will be locked at your rate for the term of the loan – a highly attractive prospect when rates are on the rise or you are on a tight budget. However, such loans are usually less flexible than variable rate loans and you may be charged for extra payments or early repayment. And although the interest rate may be lower than a variable rate loan, beware of higher ongoing fees.
Variable rate loans are usually more flexible and may include extra features (offset accounts, redraw facilities), which may help you to pay out the mortgage faster. Just be sure you really do need such features, because you’ll usually pay for them with a higher interest rate. In the event that interest rates drop, don’t be tempted to also reduce your repayments. Try to maintain the old payment levels, meaning you’ll pay off more of the principal with each repayment and reduce the term of your loan and the interest paid.
Life throws all sorts of curve balls at us and in many ways it’s best to expect the unexpected. Flexibility over the life of a loan must therefore be a key consideration when choosing your loan. Look for a loan that will allow you to meet the changing circumstances of your life. But be warned: the more flexible the loan, the higher the interest you’ll pay. Here are some popular features:
Offset accounts: Offset accounts are a simple way of reducing your loan by putting all your spare savings as well as any income earned into an offset account, which is attached to your loan. All EFTPOS, cheque, internet banking and credit transactions use your offset account. Whatever is in the offset account comes directly off the loan, or ‘offsets’ the loan amount for interest. While you do not earn interest on your savings, you benefit as what would be interest on savings is instead calculated on a reduction on your loan.
The most effective offset accounts are those that have unlimited transactions with no minimum amounts and no fees. Also look for 100% offset because others only provide a partial offset on your interest. “A 100% offset account is definitely a great way to capitalise on any money sitting in there,” says Axford. “It means you’ve got every cent you have in there working for you to reduce your interest.”
An interest free credit card is offered, which is then used for all day-to-day expenses as well as any other bills that can be paid in this way. This allows your income to stay in the offset account for a longer period, thus saving you interest on the home loan. The credit card debt is cleared automatically from the offset account on the due date, thus ensuring no nasty 17% interest rate charges. Oliver adds this tip: “Don’t use the credit card for cash as there are no interest free days for cash on credit cards.”
All-in-one account: All-in-one accounts apply the same principles as the 100% offset account by enabling every dollar of your income and savings to be used to reduce the mortgage interest. The difference is that any income you earn is paid directly into the loan account (not an offset account) to reduce the outstanding amount sooner rather than waiting for the repayment due date. Larger repayments are possible as only the amount needed to live on each month is withdrawn from the account. All surplus cash is left in the account to reduce the balance. A benefit of the all-in-one account is that it provides a one-stop finance shop where your loan, cheque, credit and savings accounts are combined into one. You may also find that you pay less in account keeping fees because all your accounts are in the one place. But you must be disciplined to ensure you only use the minimum amount to live on.
Basic loans: Some basic loans do not allow you to make extra repayments or charge you for the privilege. Make sure you understand the terms of your loan and any restrictions you will face before committing. However, also consider whether a loan with all the trimmings is really required.
There are benefits to basic loans. For one thing, interest rates on basic loans are often lower than rates on standard (premium) and equity (line of credit) loans. If all you need is a no frills loan, is it really worth paying extra?
Shredding thousands of dollars off your mortgage is not difficult to do. With a little research, good advice and savvy decision-making, there’s no reason why you can’t transform your mortgage into something significantly less onerous than a death pledge.
If your current mortgage isn’t meeting your needs and you decide to refinance, take note of the following:
1) Mortgage churn: Don’t be talked into refinancing by unscrupulous brokers who are more interested in their commission from lenders’ than they are about your best interests.
2) Early payout fees: These will vary from lender to lender, and are most likely to apply to variable rate mortgages.
3) Exit and deferred establishment fees: If you pay out the loan early you could be charged an exit fee, either a set amount or the equivalent of several months’ interest or a percentage of the original amount borrowed.
4) Establishment fees for new loans: These can run up to $800, so don’t forget to factor these costs into your calculations or you could be in for a nasty surprise.
5) ‘Honeymoon’ rates: These only apply for a limited introductory period and are then likely to rise to a higher variable rate. Make sure you know what the new rate will be.
6) Other costs: These will include mortgage stamp duty, legal and property valuation costs.
7) Variable rates: While your new lender’s variable rate may be attractive now, there’s no way of predicting how this will change over time, so any short-term benefits may be wiped out in the long term.
8) Debt consolidation: Consolidating short-term debts such as credit card, overdrafts, car loans into a long-term debt such as a mortgage may mean lower interest and thus lower monthly repayments in the short term, but you could be paying back your credit card purchases 30 years down the track, thus ruining any immediate benefits.
It can be confusing to know whether to get a variable rate or fixed rate mortgage, and what features are important. That's why it's important to not only check the right rates, but make sure that you're getting the right features in your home loan. Get help choosing the right home loan