A low-rate environment creates an opportunity for current borrowers to build a mortgage buffer, save on loan costs, and shave years off of their home loans. This chance, however, might not last forever given the wider dynamics at play, including economic growth and job creation.
A mortgage has a significant impact on borrowers’ finances, and the quicker they get it off their back, the sooner they can achieve financial freedom. Taking advantage of the low-rate environment to build a mortgage buffer is a practical move for borrowers in great financial shape. Not only will this help them plan ahead, it will also be able to cushion the risks should any unforeseen circumstances dampen their finances in the future.
What is a mortgage buffer and how do you build one?
Defining “mortgage buffer”
Think of a mortgage buffer as a separate fund that you pay on top of your monthly repayments. This fund, which will be tied to your home loan, can help reduce the interest charges and trim the time it takes to service your mortgage.
A mortgage buffer helps protect you from uncertainties in the future. Sudden changes, like loss of job, sickness, rate rises, and accidents, could potentially make a significant dent your finances — a home loan buffer will offer a breathing room to prevent you from sinking to a financial trouble. In simplest terms, a buffer gives you peace of mind should you find yourself needing financial support in the future.
Building your home loan buffer
There are three major ways of building a home loan buffer. Borrowers with variable-rate loans have the flexibility to do these things:
1. Making extra repayments
The easiest way to kickstart your buffer is paying extra monthly. Additional payments are accounted against the principal amount of your home loan, therefore reducing the interest charged to you over the life of the loan.
There are two ways to make extra repayments: making an additional monthly payment and making a lump-sum payment.
Interested how much you can save with extra repayments? Try Your Mortgage’s Extra Repayment Calculator.
2. Getting an offset account
Another great way to create a home loan buffer is saving in an offset account. An offset account works like a high-interest savings account. Funds in it are held against the daily balance of your loan, hence the term “offset”. This way, interest will only be charged to the difference between your loan balance and the funds in your offset account.
Given that it works like a savings account, you can easily withdraw your funds should you need additional cash. However, you need to be careful with the outflow of money from your offset account. You will not be able to take advantage of the reduced interest if you constantly withdraw your funds.
Read more about offset accounts here.
3. Asking for a redraw facility
A redraw facility combines some of the elements of extra repayments and an offset account. With a redraw facility, you will be able to access the pool of extra repayments you make on your loan.
If you leave the pool of funds untouched, you will be able to pay off your loan faster as extra repayments are held against the principal amount of your loan.
This home-loan feature, however, may incur fees. Before getting a redraw facility, read this guide.
Speaking to a broker about mortgage buffer
A mortgage broker will be able to help you determine the best strategy to build your home loan buffer. The strategies mentioned above have their own advantages and disadvantages — it is crucial that you base you decision on your financial habits and your needs.