The current falling interest rates provide the perfect environment to help you reduce your debt. Genavieve Zoeller reveals practical strategies to help you pay off your mortgage in no time
Keep paying the original rates even if your rates fall
Continue to pay the original repayments even if your lender slashes rates. This way you're building a buffer for future rate rises as well as saving interest.
If you're making your repayments based on the rates from August last year, you would be paying 3% more than your current minimum monthly repayments. These extra funds would go a long way towards paying off your mortgage faster.
Assuming you were paying a variable interest rate of 9.5% pa each month on your $400,000 home loan taken over 30 years, your monthly repayments would
be around $3,363 a month. In the 30 years of your loan term, you'd pay $810,830 in interest.
If you were paying this amount each month and decided to accept a 1% drop in your rate from your lender, you'd be paying $3,076 a month. This would give you an overall saving of $103,595 over
the life of your loan.
However, if you continue to make the high repayment of $3,363 each month - that's $287 in addition to the $3,076 - you'll reduce your total interest paid by $227,947 and pay your loan off eight years and two months faster.
Make the same repayment, but more often
One of the simplest and most effective strategies in reducing the term and cost of your loan is to split your repayment into two and pay every fortnight instead of monthly. You'll hardly feel the difference on your cash flow, but it could make thousands of dollars and years of difference. Paying fortnightly essentially means you'd be making 13 monthly payments rather than just 12.
If you were making repayments on a $400,000 home loan on a variable interest rate of 6.5% for 30 years, you'd pay $2,528 at the end of each month. Using this payment method, you'll end up paying $510,178 in total interest during the term of the loan.
Whereas if you use the 'half monthly paid fortnightly' method you'd pay $1,264 every fortnight, and only incur $392,682 in total interest over the term of the loan. This means you'd save just under six years on the term of your loan.
Become a frequent payer
Get into the habit of paying more into your home loan whenever you can.
Interest is calculated on a daily basis, so the more you pay the less interest is charged and the quicker you'll be free of debt. If you can get into the routine of making additional payments each week, fortnight or month, you can significantly reduce the interest and slash years off
This is suitable for borrowers whose loan features allow them to make unlimited free additional repayments with no minimum amount required. This is usually available on all standard variable home loans. Make sure you also have the ability to redraw these additional repayments if required at no cost attached.
Get a head start - pay your
If you want to kick-start your savings early, consider paying all of your home loan establishment costs and settlement costs upfront including the lenders mortgage insurance. Otherwise, capitalising these costs would significantly increase interest charges over the term of the loan.
Assuming upfront costs:
Loan application fee: $600
Valuation fee: $200
Note: your lender may also offer to capitalise your legal costs as well, pushing this figure up between $1,800 and $2,500.
This would increase your home loan to $407,560 and increase your monthly repayments by $48 to $2,576 a month. Over the 30-year term of your loan this extra amount can add up to $17,280.
To reduce your loan even further, consider making your first repayment on settlement day, instead of at the end of your first month in the property. This way, you're already ahead of your repayment schedule and have reduced your principal loan amount from the word go.
Ready offset go!
Another effective way of making your money work harder for you is by using your salary and savings to offset your loan, by paying it directly into the outstanding mortgage account.
This method works on the basis of funnelling all of your income and savings into a facility that will either:
a) 'offset' or annul the interest which is charged against a portion of the balance
of your loan, or
b) directly reduce the loan balance upon which interest is calculated
If you have an emergency fund sitting in a bank account somewhere earning little or no interest, you'd be better off depositing these savings on the loan where it will earn the same rate as your mortgage and it's tax free.
You can still keep your every day account separate, but every dollar in this account offsets your mortgage loan account. Because interest is calculated daily, the longer you leave your money in your offset account, the more interest you'll save.
A 100% offset account will work best for borrowers with substantial savings.
For example, if you have $30,000 in your offset account for the full 30-year term of a $400,000 loan at an interest rate of 6% pa, you can save around $123,722 in interest over the term of your loan and reduce the term by four years and three months (assuming your interest rate doesn't change).
If you don't have large amounts of savings, or the ability to save a large chunk of your income each month, a better alternative would be to opt for a regular standard variable or basic 'no-frills' variable loan that allows extra repayment and redraw function.
Pay lump sum
If you're the type of borrower who receives regular lump sum commissions from your employer, you might want to consider making additional lump sum repayments into your loan account (if your loan allows this without additional cost).
If you're interested in a lump sum strategy, look at the table above with an example based on a home loan of $300,000: one borrower pays a lump sum of $5,000 every six months in addition to their regular principal & interest (P&I) repayments (which shortens the original 30-year term), and another borrower pays only the monthly repayments.
By putting a regular lump sum towards reducing your mortgage, the savings in total interest repayments and the total paid are substantial.
If you're able to accumulate smaller amounts which total, say, $5,000 during the six months (as opposed to a lump sum), a more effective option would be to park it into the loan as you go along, rather than waiting six months, and utilise the interest savings as soon as possible.
Take a shorter loan term
Choosing a shorter loan term 'forces' you to pay your home loan off faster. This can be a very effective strategy for any type of borrower, as long as they can afford the higher repayments. Consider the scenario where you choose to take your loan over 15 years instead of the usual 25-30 years. This strategy requires the borrower to be very disciplined with their repayments.
However, the table above shows how this method can reduce your interest repayments and total paid substantially.
If you feel as though the pressure of the higher repayments is taking its toll on your cash flow position, or if you're hit by an unexpected financial expense, you should have the option of re-amortising the loan to a longer term, by contacting your lender.
According to Michael Lee, spokesperson for Mortgage Key Facts, most lenders will do this for the price of a variation fee which should be "a couple of hundred dollars" and there's little paperwork required. YM
Sources: Darryl Simms, managing director of Access Loans; Michael Lee, spokesperson at Mortgage Key Facts; Martin Castilla, personal mortgage advisor with Smartline; Robert Projeski, managing director of Australian Mortgage Options; Melos Sulicich, CEO of RAMS; and Your Mortgage.