One of the most sure-fire ways to save on interest charges and reduce your loan term is by making extra repayments on your loan. An average borrower will take anywhere from 25 to 30 years to finish paying off their mortgages, but paying extra can shorten the time required to settle the loan by a months or even a year or two.
Here are the things you should know about extra repayments and how you can maximise them to save both time and money in the long run.
How do extra repayments work?
Extra repayments are additional funds that you pay on top of your regular repayments. They may come in two forms: regular additional payments and a lump-sum payment.
These additional payments directly pay down the principal part of your home loan. Given that loan charges are based on the principal amount of your loan, reducing it in the shortest possible time also trims down the accumulated interest. Making extra repayments during the early part of your loan term will help you maximise the savings this loan feature can provide.
Does your mortgage payment go down if you pay extra?
A frequent misconception about extra repayments is that they lower regular repayments in the future. Take note that extra repayments are not considered advanced payments and will not serve as a "buffer" that will allow you to skip repayments in the future. If you are planning to have a repayment holiday, you should discuss with your bank the possible options available for you.
However, extra repayments cut the overall costs you have to pay. As mentioned earlier, these additional payments allow you to reduce the interest charged to your loan.
How much can you save by making extra repayments?
To illustrate how much you can save when you pay regular extra repayments, here is a sample computation using Your Mortgage's Extra & Lump Sum Payment Calculator:
For this example, let us say you have a $560,000 loan with a loan term of 25 years and an interest rate of 3.25%. In the 10th year of your loan, you decided to add $100 extra on your monthly repayments until the end of your loan term. How much will you be able to save in the long run?
Given the situation above, you will be able to save around $5,600 in interest charges. You will also finish paying off your home loan eight months early.
However, using the same figures above, let us say you made a lump sum payment of around $10,000 by the 15th year of your loan term. This is on top of the $100 regular payments you started making by the 10th year. How will these affect the interest and your loan term?
With the additional lump sum payment, you will be able to save as much as $9,600 and reduce your loan term by as much as one year and one month.
You will get to reduce interest charges if you start paying extra earlier. For instance, if you started paying an additional $100 on the fifth year of your loan, you would save roughly $10,300 and finish your mortgage one year early. If you added a lump sum of $10,000 by the sixth year of your loan term, the overall savings would be $18,600. Furthermore, you would be able to trim down your loan term by one year and seven months.
Take note, however, that Your Mortgage's Extra & Lump Sum Payment Calculator assumes that the interest rates remain the same throughout the loan term period. Try to play with your numbers using the calculator here.
Is it worth it to pay extra on your mortgage?
Paying extra on your mortgage will help you save in the long run. You will not immediately feel the impact of your extra repayments, but doing the math will help you see how much you can actually save. The earlier in the loan term that you can pay extra, the more beneficial it will be.
At the end of the day, however, the decision whether to pay extra will depend on your financial comfort. Do not sacrifice your other urgent needs to funnel all your funds to your mortgage. If you have other personal debts, it is best that you take care of those first while making your regular mortgage repayments. Only make extra repayments if you are financially stable.
You can reach out to home loan specialists to help you with your plans on making additional payments on your loan. They will be able to guide you with the ups and downs of extra repayments. Visit Your Mortgage Broker for more details.