Halve your mortgage
You’re at that point in life where you want to get the bank off your back and plan for a time where you can work less and live more. Here are some ideas to cut years and many thousands of dollars off your home loan.
Reducing your home loan as quickly as possible means you will own your major asset sooner and be able to use the money currently going into repayments to fund other things: super, investments, home improvements, trips… even fun. The following are some simple steps you can use to take an axe to your home loan and achieve financial freedom sooner.
Step 1: Find the right loan in the first place
Always consult your mortgage broker to do the shopping around for you. Make sure you communicate to your broker what’s important to you as a borrower so you can identify the type of loan you need. Bear in mind:
· Basic variable rates are lower than standard variable rates, but these days they usually come with redraw, offset and the ability to make extra repayments, so why not take the cheaper rate? A fully-featured loan will have more flexibility but a higher rate and perhaps ongoing fees.
· The big banks offer packages that have lower rates than their advertised standard variable rates.
· If you’re a first home buyer, keeping your repayments predictable and stable may be most important to you for the first couple of years, in which case having at least some of your loan on a fixed rate would be a good idea.
WHAT ARE THEY?
Standard variable: standard home loan with an interest rate that can move up or down depending on what happens to the ‘cash rate’ set by the Reserve Bank.
Base or Basic variable: have a cheaper rate than a standard variable loan but can come with less features and flexibility. Rate can still move up and down.
Extra repayments: the lender sets the minimum repayment you have to make each month but some loan let you adjust that repayment so you pay more each month and/or let you make extra lump sum payments. Any extra payments come off the principal (the amount you actually owe) so they enable you to pay your loan back faster.
Lump sum repayments: if you get an extra bit of money, perhaps commissions from work or a tax refund cheque, most variable (and some fixed) loans allow you to make extra one-off payments.
Step 2: Change your repayment frequency
Even though you pay monthly, interest on your loan is calculated daily. Moving from monthly to fortnightly, weekly or even daily payments means you pay off your loan faster and pay less interest in total – all good news. The higher the repayment frequency, the more you’ll save, but the savings you can make by changing repayment frequency are relatively small. To make a major impact on the size and length of your loan, try and make some additional repayments as well.
On a $400,000 loan over 30 years at 6.72%, shifting from monthly to weekly repayments will cut your interest bill from $531,111.20 to $530, 493.20 over the life of the loan. That’s a saving of $618. Fortnightly is the next best option, saving $430.80.
Step 3: Pay more and pay early
Home loans are structured so that during the first few years you are paying just about exclusively the interest component of the loan. That means the actual amount you owe (the principal) doesn’t seem to get smaller at all. Any amount of money you can pay into the loan above your required regular repayment will reduce the principal. In turn, your interest will be calculated on a smaller outstanding amount. This is by far the best way to make a substantial impact on the overall interest you’ll pay during the life of your mortgage.
Extra lump sums or regular additional repayments can help you cut many years off the term of your loan.
Step 4: Make the most of redraw and offset accounts
Another effective way to reduce your home loan is to use salary and savings to offset your loan, in one or both of the following ways.
- 100% offset account: This is like a normal bank account that you can deposit and withdraw from on a daily basis, but it is attached to your home loan and any money you have in the account is ‘offset’ against your principal (the amount that is still outstanding on your loan). This means your interest payments are calculated on a smaller loan amount, so you pay less interest.
- Redraw facility: This allows you to make extra payments (to reduce the principal and so pay less interest) but draw them back out again if you unexpectedly need the cash later. A bit like having your cake and eating it. Why not stick your emergency cash or what you’re saving for your kids’ schooling into a redraw facility instead of a high-interest account? If you think about it, the banks are always going to charge you more interest on your mortgage than they pay you on your high-interest account (eureka moment – that’s how they make their money!), so you’ll save more interest on your mortgage than you gain on your high-interest account (especially given the interest you earn is taxed at your marginal rate). And because interest is calculated daily, the longer you leave money in a redraw or offset account, the more you’ll gain.
TIP: If you don’t have large amounts of savings, or the ability to save a large chunk of your income each month, a basic variable home loan that allows redraw and extra repayments but doesn’t have ongoing fees may be a better bet than a 100% offset account, which usually comes with a higher rate.
Step 5: Resist ‘generous’ offers
Beware of honeymoon rates and other sweeteners. At the moment, lenders are being super-competitive. They are offering to waive application fees and if you’re refinancing will even pay up to $1,000 off your current loan’s exit fees. Honeymoon deals, which offer lower rates for the first year or more, are also popular. But with all of these offers you have to think long-term. Work out the total cost of the loan over its entire life – rather than being wooed by the ads – to see whether any given offer is really worth it to you.
Step 6: Refinance to a better deal
The home loan you chose five years ago because it was the best on the market is probably not still the best. By late 2011, interest rates were extremely competitive in comparison with one year earlier.
Fixed-rate loans, in particular, currently represent better value than standard-variable offers. That generally occurs when lenders think rates are going to fall further. To find the best current refinancing deals and for guidance about when refinancing works and when it does, call your mortgage broker.
To discuss this article or anything to do with your finances, please call our office today and we would be happy to assist you.