For many Australians, buying a home is the most expensive financial transaction they will ever make. Homeownership takes financial commitment — for the next 30 years or so, you will be allocating a portion of your monthly income to settle your mortgage repayments.
When borrowing funds to finance your home purchase, it is essential to remember this principle: the longer you pay for your mortgage, the higher its cost will be. In fact, there are times that the accumulated interest charged to you is larger than the home loan itself.
Think of it this way: while it is true that having a more extended mortgage period means you pay less monthly, you might have been just prolonging your financial burden. What you need to do is look for ways to shave time off your mortgage term and save big on your mortgage interest.
Here are some of the tried-and-tested ways to help you save up some cash and cut your home-loan term:
Make Extra Repayments
Over the life of your loan, you will be paying for interest charges, which actually make a bulk of the total amount you are bound to pay.
One of the easiest ways to reduce your interest charges is by making extra repayments. There are many ways you can do this: You can start boosting your monthly repayments even by a small amount or you can also make lump-sum payments.
To illustrate how making extra repayments slashes your mortgage term and helps you save on interest, consider this: You have a $475,000 home loan with a 4.5% interest rate and a 30-year mortgage term. On a monthly basis, you pay $2,406.76 towards your home loan.
If by the fifth year of your mortgage term you start adding $300 to bring your monthly repayment to $2706.76, you will get to cut your mortgage term by four years and seven months, saving you as much as $60,000. If you decide to go for a bigger boost, say $400 monthly, you will save as much as $74,700 over the life of the loan, reducing your home-loan term by five years and nine months.
On the other hand, some borrowers find satisfaction in saving up and paying a lump sum rather than adding little to their monthly repayments. Doing this can also help you save on your home loan.
Let's consider the same scenario as earlier, but this time, you decide to pay a lump sum of $50,000 by the 60th month or fifth year of your home-loan term. You can then save as much as $88,500 in interest and cut your mortgage term by four years and nine months.
Before even considering these, however, you first have to ask your lender if you can make extra repayments and if there are no fees associated with doing so.
The computation for extra monthly repayments and lump sum boosts are different. But if you want to explore your options, try our calculator here.
Change your repayment schedule to bi-weekly or weekly
Another easy tweak to finish your mortgage early and save on interest charges is by changing your repayment schedule from monthly to weekly or fortnightly.
The main idea behind this strategy is that you get to squeeze in an extra monthly repayment every year if you pay fortnightly or weekly. There are 26 fortnights and 52 weeks in a year — both are equivalent to 13 months.
If you allocate $2,000 for monthly repayment, by the end of the year, you would have paid $24,000. Make it $1,000 every fortnight and you would be able to pay $26,000 annually. That extra $2,000 repayment will do much to shorten your mortgage term and cut a significant amount of interest.
It is important to note, however, that some banks may have different arrangements on fortnightly repayments. Many follow the example mentioned earlier, but others charge fortnightly repayment as your total annual repayments divided by 26 fortnights — this means that the $24,000 yearly repayment will be divided into 26 bi-weekly dues.
You have to ask your lender about their arrangements to help you understand how switching from a monthly repayment to weekly or fortnightly can help you save.
Using an offset account
An offset account can do wonders — not only it can serve as your savings account, but it can also reduce the interest charged over your loan.
If you get a home loan with an offset feature, you will get a transaction account linked to your mortgage. An offset account works like a regular savings account, allowing you to stash extra funds you have while at the same time giving you instant access to your savings. You can withdraw your funds anytime through phone banking, ATM, or over the counter.
How does an offset account help you save on your loan? An offset account operates like a high-interest savings account — the amount of money you have in one is accounted daily against your loan balance, slashing the interest charged to you.
There are two types of offset account — full or partial. If you have a $500,000 home loan with a 4.75% interest rate and you have $50,000 in your offset account, interest charges will only apply to $450,000. This is how a full offset account works. Some lenders, on the other hand, only allow partial offset accounts where only a portion of the funds stored will be accounted daily against your loan balance.
For it to work, an offset account should contain funds. A standard way of ensuring that your offset account always has a balance is by asking your employer to pay your salary into it. You can also use your offset account as your primary savings account — the more you save, the more significant portion of your loan is freed from interest.
You have to remember, however, that the funds you have in your offset account are not considered extra repayments. They are not deducted from the principal amount you owe your lender — they merely help you reduce the interest charges.
Consider redraw facilities
Another popular strategy among borrowers to save on home loans is using redraw facilities.
A redraw facility, like an offset account, allows you to save a pool of funds while paying your home loan. This time, however, the funds that you put in your redraw facility are considered extra repayments.
Redraw facilities are perfect for borrowers who wish to pay off their mortgage earlier. All the payments you put towards your redraw facility will be deducted from your principal.
You can fill your redraw facilities either by making regular extra repayments or paying a lump sum. The good thing about redraw facilities is that you can access the extra repayments you made.
However, it does not work the same way as an offset account — a redraw facility does not give you ready access to the funds. In order to use the funds you have saved, you have to process it first with your lender and you might have to pay a fee. Some lenders even impose restrictions, limiting the number of redraws you can make and the amount you can withdraw.
Refinance for better interest rates
If there are no other options, you can refinance your current mortgage to a better home-loan deal or switch lenders.
In most cases, borrowers refinance their home loans with a new lender. But in some instances, you can speak with your lender to discuss if refinancing options are available.
How does refinancing work? Refinancing a mortgage means going through the process of the home-loan application again. This time, however, it is somewhat easier since you have already transacted with a previous lender. What you are gunning for this time is a lower interest rate.
A slight change in interest can mean a lot. Think about this: if you have a $500,000 home loan with an interest rate of 4.25% and a mortgage term of 30 years, you will have to pay $2,533 monthly. Over the life of the loan, the total interest you will have paid is $412,033.
If you squeeze your interest rate slightly lower to 4%, your monthly repayment reduces to $2,387. The $146 difference seems small, but if you take a look at the cumulative interest cost you will have paid with this new rate, the amount will go down significantly to $359,347, saving you $52,686.
A 25-basis-point interest-rate reduction already reduces your home-loan costs significantly — you can just imagine how much you can save with a 35- or even a 50-basis-point rate cut.
It is crucial, however, to consider the costs of refinancing — yes, the process will incur some fees. Always remember that when you refinance, the benefits should outweigh the costs. A small interest-rate change might not be able to cover the expenses you will incur, so it is better to study the situation carefully to ensure that you are making the wise move.
Some of the fees you have to be aware of are:
1. Mortgage discharge fees
These are not exit fees — these are often charged by lenders when you close a home loan account to refinance with another lender.
2. Break cost
If you refinance within your fixed-rate term, you will incur a fee for not fulfilling your part as stated in your agreement. This fee depends on the number of years left on your fixed-rate term and the interest at the time you close your account.
3. Switching fee
You will be charged this fee if you refinance your mortgage product to another home-loan deal your lender offers.
4. New application charge
If you are applying with another lender, you will likely pay this fee as your transaction is considered a new application.
5. Valuation fees
This will also be charged to you if a new lender conducts a valuation of your property. If your property's value decreases and the amount you are borrowing is more than 80%, you might also be charged with Lenders Mortgage Insurance.
There may come a time when your home loan just won’t work anymore with your current conditions — maybe you wanted more from your lender, but it is not able to give you what you demand.
When that time comes, it is only fitting for you to start shopping around for other home-loan offerings. The previous item talks about refinancing for a lower interest rate. However, you can also refinance for a myriad of reasons:
1. Finding a home loan with better features
It's not always the interest rates that count when choosing a home loan. When you shop around for mortgage offerings, consider looking for those which offer not just low-interest rates but useful features that can help you save on your loan.
Aside from offset accounts and redraw facilities, here are some of the home-loan features you should look for:
· Flexible repayments
Check if your target lender is open for extra repayments with no additional cost. This feature will help you pay off your home loan sooner.
· Repayment holiday
Another great feature is having a repayment holiday — this is when you get to hit the pause button in paying repayments. This feature is useful to cover unforeseen circumstances that would temporarily disrupt your budget, rendering you unable to settle your monthly dues.
· Flexible rate options
If the lender offers split loans, then you will be able to take advantage of their current fixed and variable rates. You can also ask your lender if they offer interest-only mortgages.
2. Accessing the equity in your home
Equity is the difference between the market value of your home and the amount you still owe on your mortgage. This amount can be accessed if you refinance your home loan with a lender offering a home-equity loan.
The amount you will get can be used to finance any big purchases you are planning for: renovations, property investment and purchase of assets like shares and managed funds. You can even use the equity of your home for a new car or a family holiday. However, it is advisable to put the money towards an asset that can generate returns; this way you continue to grow your funds.
3. Increasing your repayments
There are times when lenders will not allow you to increase your repayments or shorten your loan period. In this case, the only option you have is to refinance with a lender that will allow you to do so.
You can always refinance to a shorter loan term to reduce the interest rate charged to you while at the same time helping you pay off your loan faster.
Speak with an expert before applying for loan or refinancing
Mortgage brokers will be able to help you think of ways to save big on your home loan. If you think of refinancing your loan, you should reach out to one of your trusted mortgage brokers to give you the latest home-loan options in the market.
Mortgage brokers can also help you clinch home-loan deals that are not readily accessible publicly. They have connections with lenders which could have the best deals for your situation.