It might be fashionable to use your mortgage like a revolving line of credit but if you’re serious about paying it off as quickly as possible, here are six strategies that will shave years and thousands of dollars off your home loan.
1. Find the right loan in the first place
Whether it’s through a mortgage broker or independent shopping through sites such as yourmortgage.com.au, you can make huge savings by comparing home loan products.
For example, if you’re borrowing $400,000, a home loan that’s 1% cheaper will save you $100,000 in interest and shave five years off your mortgage.
You should be looking for a competitive interest rate, but also consider what type of loan suits you best:
• Standard variable rates depend on the movements in the cash rate and usually come with a fully-featured loan
• Basic variable rates are lower than standard variable rates and may have fewer features but most allow you to make extra payments, offset and redraw
• Fixed rates offer predictable repayments which might be helpful for first-home buyers
Pier Wiernigk from Smartline says brokers can help you grab a better deal, as they are experienced in negotiating with lenders.
2. Change your repayment frequency
Although you pay monthly, the interest on your loan is calculated daily. By increasing the frequency of your repayments, you’ll pay off your loan faster and pay less interest overall.
For example, if you switched from monthly to fortnightly payments on a $400,000 loan at 6.72% over 30 years, you’ll save $618 over the life of the loan.
When you approach the bank to change the frequency of your repayments, check how they calculate the amount. The best method is multiplying the monthly repayment by 12/26
3. Pay more and pay early
Mortgages are structures such that borrowers spend the initial years paying off the interest component of the loan while leaving the size of the principal unchanged. By paying above and beyond the minimum requirement early on in the term of the loan, you will reduce your principal meaning the interest will be calculated on a smaller outstanding amount.
Developing a budget can help you trim your expenses, and you’ll be surprised at how simple changes in your spending can save you interest and pay off your loan faster. Using the $400,000 home loan scenario described in the previous section, you could make brilliant savings by doing any of the following:
|What if you...||Monthly repayment||Interest saved||Time saved|
|Pay $50 extra each month||$2,636||$36,327||1 year, 9 months|
|Stop buying a $4 coffee on the way to work||$2,666||$55,604||2 years, 8 months|
|Cancel Pay TV ($132 per month)||$2,718||$85,181||4 years, 1 month|
|Buy a Holden Commodore SV6 instead of a Merc E220 Sedan and make one lump-sum payment||$49,286 lump sum payment||$196,663||7 years, 11 months|
|Stop putting $10+ in the pokies every day (save $400 per month)||$2,986||$189,493||6 years, 8 months|
“It’s also a good idea to put any tax refunds you receive towards paying off your loan”, says Belinda Williamson from Mortgage Choice.
In this low interest rate environment, another way to pay more is to continue making the same repayments next time there is an interest rate cut. You’ll be making a bigger dent in your principal.
4. Make the most of redraw and offset accounts
Williamson says that although interest rates are currently attractive, borrowers should also consider other loan features such as a 100% offset account and/or a redraw facility.
A 100% offset account works like a regular bank account that’s attached to your home loan. Any money in this account “offsets” against what is outstanding on your principal, which means your interest payments are calculated on a smaller loan amount – which reduces your interest owing.
A redraw facility enables you to make additional payments to reduce your loan but allows you to draw them back out again if you unexpectedly need cash.
Back to our home loan scenario, putting $30,000 in an offset account will save you $152,942 in interest, since you’re effectively paying interest on a principal that’s $370,000 rather than $400,000.
5. Resist generous offers
Honeymoon deals that offer discounted rates for the first year of a loan are very popular, but it’s still important to work out the total cost of the loan over its entire life to see if it will actually help you in the long term. Williamson notes ongoing discount loans as an alternative - unlike introductory rate home loans, these products provide a discount throughout the life of the loan.
As a sidenote, new home loans can no longer charge early-exit fees; however they still apply on some existing loans. Before settling your loan, make sure you’re not tied to any hidden costs.
6. Refinance for a better deal
With interest rates constantly changing, the best-value home loan you signed onto five years ago is unlikely to be the most competitive product in 2012.
It’s worth negotiating for a better rate, either directly or through a broker – you could push down your current interest rate by up to 1%.
“The mortgage industry has become increasingly competitive, so you should continue to educate yourself and keep an eye out for better products on the market”, says Williamson.
There’s no particular loan package that currently stands out from the rest, as it ultimately depends upon each borrower’s short and long-term goals and investment strategies.
Regarding fees and charges, some lenders allow you to pay this upfront or add it to the amount you’re borrowing. Looking at the scenario below, delaying the payment of $1,000 in upfront costs can set you back almost $8,000!
|Borrower A||Borrower B|
|Loan term||30 years||30 years|
|Upfront costs of $1,000||Paid upfront||Added to loan|
-- By Jackie Pearson and Stephanie Hanna