Save on interest and reduce your loan term with extra and lump sum payments
The average home loan can last a buyer anywhere from 25 to 30 years; a long time to be making repayments and incurring interest, which is why there are a few options available to significantly reduce the entire life of a home loan and any additional fees it incurs.
One of the least complicated ways to put your money to good work, is to put it towards your home loan as additional and lump sum payments.
Whether these extra pockets of cash take the form of a gift, an unexpected work bonus for all your hard-working efforts, or simply come about because you’re being diligent with your saving, the sooner you are able to contribute an added amount to your standard monthly repayments, the better. It could end up significantly diminishing the total amount to be paid on your home loan and save you tens of thousands of dollars in the long-term.
Think of it this way: extra repayments directly pay-down the principal amount of the home loan (the amount of money you loaned from the bank). And since the amount of interest to be paid is always based on the principal amount of the loan, the lower this figure sits, the less you will have to pay in interest. And who wants to be paying more?
However, it’s also important to be aware of some of the unexpected drawbacks of making extra payments. The most important one to look out for is the ‘break fee’ – which is generally only charged if you happen to pay down your fixed-rate (rather than a variable rate) home loan earlier than expected.
Considering this, it’s important for a home buyer to conduct independent research and be aware of any terms and conditions attached to their home loan product that could impact how their home loan reacts to extra and lump sum payments. It’s also advised they engage a financial adviser, accountant or mortgage broker, in deciding which repayment strategy is best suited to their financial circumstances and goals.
In the meantime, for those wanting to find out how much additional payments can impact their home loan and determine its final amount – the principal, and interest rate fees that are included – Your Mortgage’s Extra and Lump Sum Calculator can be insightful on this front.
All you have to do is provide some information, and the calculator will do the rest of the work in showing you how much you could potentially end up saving.
How the extra and lump sum calculator works
Your Mortgage’s Extra and Lump Sum Calculator will ask you to provide a few important pieces of data in order for it to perform its number-crunch.
You will need to specify the principal amount to be taken out on the home loan, the annual interest rate to be incurred, the additional repayment amount to be made each month, the month this additional repayment will commence, and any lump sum payment that will be made at a specific point in time during the life of the loan.
Whilst the interest rate is set at a constant fixed rate of 4.5% per annum (to follow throughout the entire life of the loan), this can be altered, as can the 30-year loan term, and the frequency of repayments. However, the interest rate can’t be set to fluctuate, as it would in the case of a standard variable loan.
To help you understand how extra and lump sum payments can impact the total amount you will need to repay on your home loan, here is an example provided by the calculator.
Let’s make your home loan amount a solid $800,000 and the annual interest rate fixed at 4.5% over a loan term of 30-years.
Let’s then make your additional monthly repayments (which will be made on-top of your standard monthly repayments) at $100. And let’s start this extra payment from the very first month of your home loan, or from your first monthly repayment. This additional amount will continue to be paid each month, throughout the entire 30-year period of the home loan.
Why don’t we also say you received a bonus or a commission? Let’s make it a generous $10,000, to be contributed in the 6th month from when you first took out the loan.
According to the above pre-sets, your 30-year loan term will be reduced by 2 years and 2 months, and you will save a total of $62,438 in interest repayments – a huge amount, considering the small outlay!
Even if we kept with the above pre-sets, but changed the additional monthly repayment to only $50 and removed the lump-sum payment, you could still end up saving a total of $19,393 in interest repayments.
What is more effective: A larger lump sum or more extra payments?
Whether you decide to contribute a larger lump sum, or more extra repayments, will entirely depend on your financial situation.
However, what you don’t want to be doing is diligently putting aside extra income in the hopes of one day building it up into a bigger payment amount.
Firstly, it can sometimes take a while to save, just as it did with your unpopular friend, the cash deposit. And if you contribute a lump sum towards the end of the loan term, you would have already paid a fair amount of interest towards the loan.
So, as soon as you have any funds that you plan to filter into the loan, you should take action – as the earlier in the loan term you are able to do this, the more beneficial it will be to your savings.
Of course, being able to place a larger lump sum into the home loan will instantly shave off a significant portion off the principal amount of the loan, which will also go on to reduce your loan term and the total amount of interest to be paid. But if this isn’t in your budget, or doesn’t expect to show in the foreseeable future, being able to offer extra repayments each month, or more frequently – no matter how big or small – will also reap a cost saving result.
Furthermore, whilst most home loans are set to monthly frequency in repayments, there is also the option to ask your lender to adjust your repayment cycle to come around weekly or fortnightly.
Considering that interest is charged daily, making more frequent repayments could also work to reduce the total amount of interest to be paid.
Can I cut my loan term in half?
Yes, it’s possible to cut your loan term down the line, but it ultimately depends on how much you are able to contribute towards extra payments, and how frequently you are able to make these.
Based on Your Mortgage’s Extra and Lump Sum Calculator, with a principal home loan amount of $800,000, at 4.5% interest per annum, over a loan term of 30 years, additional monthly payments of around $2,100 per month would need to be made if you are to see your loan term cut down to 15 years.
But being able to do this, can also potentially save you a mammoth $360,216 in mortgage repayments!
How far does one extra mortgage payment go?
A single extra mortgage payment can go a long way, and no matter how small, can work to shorten your loan term and the total interest to be paid. However, the bigger the extra payment, the more you will save.
The results and comparisons provided by the calculator are to be taken as a reference or guide only. Results only rely on the information provided and the assumptions that have been pre-set. Results are only based on a fixed interest rate, and the calculator doesn’t factor in variable interest-rate home loans, and that interest rates can alter or fluctuate throughout the entire life of the home loan. The calculator only factors in one single lump-sum payment, not multiple lump-sum payments, and it also only factors in a constant extra monthly repayment to follow-through the life of the loan from the start month that is selected.
It should also be noted that results do not indicate the future financial circumstances of a buyer, nor do they act as a determiner. A formal assessment should be independently sourced, advisably to be done with a financial adviser or mortgage broker who can provide a more accurate result.