Over the life of the home loan, many homebuyers end up paying their lender more than double the amount they originally borrowed. However, there are a number of ways they can actively reduce their interest bill.
The one thing almost all borrowers have in common is that they do not want to be borrowers. They want to have their loan paid off and to be debt free. If you’ve just borrowed (or if you’re just about to borrow), the day when you get the title deed on your property back from your lender may seem a very long way away. And let’s face it – it probably will be a long way away.
But don’t despair. You can take steps to pay your loan off faster and save a heap of money. Here are a few ideas that will help you along the way.
1. Skip the honeymoon
Introductory or honeymoon rates have long been an important marketing tool for lenders. The idea is to offer you a cheap rate to get you in the door and then try to keep you there at a higher rate for as long as possible (which allows them to make money on the deal).
But beware of lenders bearing gifts. Most lenders roll your loan over to their standard variable rate when the honeymoon is over. They also can hit you with fairly steep exit penalties if you want to refinance before you have been on their standard variable rate for two or three years. And the problem is that the variable rate is often higher than some of the lower basic or “no-frills” loans that are available. In fact, you can find that if you average the introductory rate with the variable rate, you’re paying up to half a per cent more than you might otherwise pay.
2. Get a cheap loan, pay at an expensive rate
While rates are low, why not get in ahead of them? Get a variable loan with the lowest rate you can find (or, better still, a fixed loan that allows you to make extra repayments) and make your repayments as if rates are what they were a couple of years ago. If you have a loan at 5% and you are paying it off at 8%, you won’t even notice if rates go up. And you’ll be paying off your loan quicker and saving yourself a packet.
Mortgage products (known as All-in-One loans or 100%) allow you to use your mortgage as your key financial product. Having a mortgage that you can pay all of your income into and draw on for living expenses as you need to – using a credit card, EFTPOS or a cheque book – can make a huge difference to the speed at which you pay off your loan. Because your whole pay goes into your mortgage account you are reducing the principal on which interest is charged. Sure you might take a couple of steps back as you withdraw living expenses, but careful use of this sort of product can get you thousands of dollars ahead of where you’d be with a “plain vanilla, pay once a month” home loan.
Keep in mind, however, that these types of loans often have a slightly higher interest rate than other types of loan. Because of this they are best suited to borrowers with relatively high incomes. If you are only able to make the equivalent of the minimum repayment on your loan (and not put in any extra) you may be better off with a cheaper standard variable or basic variable loan.
As we said before, time is money. There are all sorts of strategies for paying less interest on your loan, but most of them boil down to one thing. Pay your loan off as fast as you can.
Consider the following example of a loan of $300,000 at 6%:
If you pay out the loan over a term of 30 years your monthly repayment will be around $1,799. This equates to a total interest repayment of $347,515 over the term of your loan.
If you pay the loan out over 25 years rather than 30 your monthly payment will be $1,933 a month. But the total interest amount you will repay over the term of the loan will only be $279,879 – a saving of a whopping $67,644!
The simple things in life are often the best. One of the simplest and best strategies for reducing the term and cost of your loan (and thus your exposure should interest rates rise) is to pay fortnightly rather than monthly. How could this make a difference I hear you ask?
It works like this, split your monthly payment in two and pay every fortnight. You’ll hardly feel the difference in terms of your disposable income, but it could make thousands of dollars and years difference over the term of your loan. The reason for this is that there are 26 fortnights in a year, but only 12 months. Paying fortnightly means that you will be effectively making 13 monthly payments every year. And this can make a big difference.
Over the first few years of your mortgage, it may seem that all you are paying is interest, and the principal isn’t reducing at all. Unfortunately, you’re probably right. Early in your loan, by far the majority of your repayments go to paying interest. So try anything to get some of the principal repaid early, you’ll notice the difference.
7. A dollar today vs a dollar tomorrow
An important issue to come to terms with when choosing a home loan is the time value of money. The essence of this theory is that a dollar today is not necessarily worth the same as a dollar in the future. Consider the example of two otherwise identical loans, one with a $1,000 upfront fee and the other with a fee of $100 per annum over 10 years. Which is the better loan?
With the second loan you can pay your $100 dollars at the start of the loan and put the other $900 in an interest bearing account. At the start of the second year you can pay the second $100. At the start of the third year you can pay the next $100 and so on. Because your money is sitting in your interest bearing account for longer (rather than that of your lender), you are better off.
Speak to your lender about what financial packages they have on offer. Some offer discounted home insurance, some offer fee free credit cards, some offer a free consultation with a financial advisor or a fee free transaction account. While these things may seem small beer compared to what you are paying on your home loan, every little bit counts and sometimes you can use little savings on other financial services and turn them into big savings on your home loan.
If you don’t ask for it you won’t get it. Remember that competition among lenders still exists. Try twisting their arm a little bit. Asking your lender for half a per cent off their rate might not work, but see whether they will give you a break on establishment costs or ongoing fees.
10. Split your loan
A split loan, or combination loan as they are often known, allows you to take part of your loan as a fixed and part as a variable. Essentially, this allows you to hedge your bets as to whether interest rates are going to rise and by how much. If interest rates rise you will have the security of knowing part of your loan is safely fixed and won’t move. But if interest rates don’t go up (or if they rise only slightly or slowly) then you can use the flexibility of the variable portion of your loan and pay that part off more quickly.
It may sound like a simple statement but switching out of your current loan and taking out a loan at a lower rate can mean the difference of years and thousands of dollars. If you have a loan that is tricked up with all the features, or even if you have a standard variable loan, you might find that you could get a no frills rate that is as much as a percentage point cheaper than your current loan.
12. Forego those minor luxuries
This is the bit you don’t want to read. Once you have a mortgage, your life is likely to be luxury free (or at least pretty close to it). Think of all the weight you will lose by giving up your favourite indulgent snack. For the sake of your health you should quit smoking and drink less anyway. All the money you save should go to reducing your principal and saving you money in the long run.
The temptation is always to let your mortgage roll along, make your repayments as they are due and think as little about it as possible.
This can be a big mistake. Keep yourself up to date with what’s happening in the marketplace. You might find that there’s an opportunity to put yourself well ahead of the game.