Ways To Pay Off Your Home Loan Faster
Tuesday, October 13, 2015
If you’re currently repaying a home loan (or looking to do so), you may be finding yourself a little moody of late.
Sometimes, you may find yourself a bit excited. After all, Australians are currently enjoying some of the lowest interest rates they’ve ever known. This is allowing a greater number of Australians to borrow more and more easily repay their existing home loans. In the past three years, Australia’s average first-time home loan has increased by 23%. And, whereas 2007 saw only 16% of Australian home-owners living mortgage-free, 25% of us could make a similar boast in 2014.
But, at other times, you may find yourself feeling a bit anxious. A little bit worried, even. If you’ve already got a home loan, you may find yourself worried by reports that interest rates might start to climb again in 2015. Or, by recent reports that some Australian banks and lenders may have been lending irresponsibly. If you’re thinking about getting your first home loan, you may simply be concerned by reports that Australia’s housing market in some Capital cities might currently be in the midst of a soon-to-burst bubble.
In any regard, you may find yourself thinking of the future of your home loan – worrying if you’ll be able to keep managing your repayments. You may already be looking for ways to pay off your home loan sooner – or to live that dream of paying off your mortgage in five years. We’re going to try and make things a bit easier for you. In today’s article, we’re going to have a look at six strategies that you can use to keep your repayments down or pay off your mortgage faster.
Now, there are some things you can do before you even get a home loan that will help you keep your repayments steady. Obviously, these strategies won’t be much help if you’ve already got a home loan. But, we don’t want to leave anybody out. So, we’ve divided our list into Pre-Loan Strategies and Post-Loan Strategies.
If you’re planning on getting a home loan, you can use all of them. If you’ve already got a home loan, only some may apply – but, where possible, we’ve tried to make our advice work for everyone.
In any regard, we hope you find these strategies helpful.
1. Save & Budget Conservatively – Don’t Rush In
A little boring, perhaps – but highly effective. One of the best ways to avoid being caught in escalating loan repayments is to make ample preparations and to not rush the process of applying for a loan or buying a house. As in most things, ample preparation can help you achieve your goal of paying off a home loan sooner.
What does preparation mean, in practical terms? Well, as we’ve covered before, it’s technically possible to secure a home loan with only 5% of the purchase price if you’re willing to pay insurance or have someone to act as a guarantor to the loan. This may even be particularly tempting right now, given Australia’s current low interest rates. But, 95% of a home’s value generates significantly more interest for you to repay than if you had, say, a 20% deposit and only had to borrow 80% of the home’s value. Furthermore, if interest rates do rise and you’re not prepared, your mortgage repayments may get away from you.
This is also something to consider even with a loan with a higher percentage deposit. You may be able to afford to make repayments with 4% interest – but what if rates should climb to 6% or higher? When budgeting for your prospective home loan, anticipate that you may be making repayments at a higher interest rate in the future. In this way, if interest rates should climb, you’ll already be prepared. If they don’t increase, you’ll still be equipped to pay off your home loan faster and if you repay more than you have to, you’ll pay less interest over time.
If you’re unsure what rate to use to estimate your budget, the Australian Prudential Regulatory Authority (APRA) recently recommended that banks and other lending institutions assess people’s finances on the assumption of interest rates of 7% – or, at the very least, interest rates 2% higher than the current rate. These figures were based on previous shifts in the Australian market and should give you a good figure to work with in planning your budget.
For Existing Home Loans – There’s also a good strategy here for keeping on top of your existing home loan repayments and paying off your mortgage quicker – always calculate and make your repayments with a slightly higher interest rate than necessary. Again, it’ll help you pay off your loan faster and keep you amply prepared for any future shift in interest rates.
2. Consider A Split–Interest Rate Loan
Typically, loans are discussed in terms of fixed or variable interest rate. Given Australia’s current low interest rates, you may be tempted to opt for a fixed rate home loan. But, a fixed rate home loan can often preclude future flexibility with repayments or making changes to your loan.
For example, exit fees were banned for Australian variable rate loans in 2011 – but they still apply to fixed rate loans. This means if you want to change to a different lender or a different loan further down the track (or even pay off your loan early), you’ll have to pay. The other thing to remember is that you can usually only fix your interest rate for a limited period of time. Usually, three to five years.
But, in spite of all of that, you may still be concerned about taking on a variable rate loan if interest rates increase unexpectedly. Fortunately, you needn’t choose between one or the other. A split-rate loan allows you to fix a portion of your loan at an existing rate and take advantage of variable rates for the remaining portion. It can be the best of both worlds.
If you’re unsure about the pros and cons of each type of loan, we’ve previously covered both fixed vs variable and split-rate home loans in detail on Insight. Figure out which one will be right for you and your mortgage repayment plans.
For Existing Home Loans – If you have an existing home loan, you may be able to negotiate a split-rate arrangement further down the track. Speak to your loan provider and see what’s possible for your loan.
3. Consider Offset Account & Cashback/Redraw Options
Offset Accounts & Cashback Options can be instrumental in helping keep your loan repayments down over time or to help you quickly paying off a mortgage.
If you’re unfamiliar, an offset account that is fully offset against your home loan allows your bank balance (in a linked account) to count towards paying off your home loan. For example, if you have $300,000 to repay on your home loan and you have $50,000 in your bank account, you’ll only be charged interest on $250,000 of your loan.
Cashback/redraw options, meanwhile, allow you to redraw any additional payments you’ve made on your home loan in case you need an emergency influx of cash. If you only need to pay $1000 a month and you pay $2000 for three months, you’ll still be able to get $3000 of your repayments back if and when you need it. Keep in mind there may be fees associated with cashback options so make sure you talk to your bank.
These two features allow you to use your existing money to reduce the interest you have to pay on your home loan without actually having to concretely increase your regular repayments. Not all home loans come equipped with these features, though, so make sure you look to include them in your selected loan.
For Existing Home Loans – you may already have access to these features and simply haven't used them. Or, there may be additional money you have in savings that could be used with these features. Both offset and cashback can effectively be using as saving accounts that lower your interest rate. Speak to your lender and explore your options.
1. Shift to Weekly/Fortnightly Payments
You may think that it doesn’t matter how regularly you make your home loan repayments. After all, is there much difference between one payment of $1000 a month and four payments of $250 a month? It’s all money, right? Not exactly. If you want to keep your repayments down and pay off your loan quicker, one of the best things you can do is shift to more regular repayments.
It actually helps in a couple of ways.
Firstly, you’ll simply make more repayments. There are twelve months in a year (which, at four weeks a month, equals forty-eight weeks). If you’re making monthly repayments of $1000, you’ll have paid $12,000. There are, however, twenty-six fortnights in a year. If you’re paying $500 a fortnight (which we can agree is the same rate as $1000 a month), you’ll pay $13,000 a year. The same applies if you pay 52 weekly payments of $250.
So, automatically, you’re paying off your mortgage faster.
Secondly (and more subtly), you’ll pay less interest. Your interest is calculated on the basis of how much is left outstanding on your loan at the end of the day. The more regularly you reduce that outstanding amount, the less interest you will have to pay. If you’ve got $250,000 on your home loan, it’s obviously better that it only accrues interest at $250,000 for a week or a fortnight rather than a month, right? Next fortnight, it’ll calculate interest at $249,500 or $249,000.
As time goes by, you’ll reduce your interest more and more.
It may seem like a small change– but those changes can make a huge difference.
2. Steer Clear of Interest-Only Payments (Or Use Them Wisely)
You may have an option on your home loan that allows you to temporarily devote your repayments exclusively to your accrued interest. If you want to keep your repayments down, you should be careful with this option. Remember, while you’re only paying off interest, your principal is still accruing more interest. It’s like when you’re digging a hole at the beach and the soft sand just keeps pouring in.
If you do have an interest-only option on your loan, you should use it to pay off your interest as quickly as possible so that you can start making a serious dent on your principal and reduce the overall interest you have to pay. This can be one of the better strategies for goals like paying off your mortgage in five years. As we demonstrated above, the quicker and more regularly you can reduce your principal, the less interest you’ll have to pay and the less your repayments will be.
So, if you do have an interest-only repayment option, be strategic about it.
3. Stay Up-To-Date
It’s important to keep reviewing and updating your home loan. In five years, a country’s economy and property market can and will change drastically around you. In 2014 alone, Australian housing prices in capital cities rose by 8%. As such, your home loan will not necessarily always be the best deal for you. Don’t fall into the trap of thinking that it’s a static debt that cannot be changed or altered.
You should compare your home loan with other home loans on the market roughly every three years. If there are significant differences, you should investigate and see if you can benefit from them. You could pay off your mortgage sooner with a more strategic or competitive arrangement. We’ve covered a couple of approaches you might consider already. You may want to shift to a split-rate home loan or explore the options of a cashback option. But, you may also wish to refinance and move to another lender with a better rate or better options.
The conventional wisdom is that such a manoeuvre is usually too expensive or complicated to bother with – but explore your options before you make that decision. Remember, exit fees on variable rate loans were banned in Australia in 2011 (and the Australian Government have stressed that any lender who tries to apply them to a mortgage under another name would face prosecution and fines). There may be an option for you.
In any regard, it’s important to not take your home loan for granted if you want to keep your payments down. Especially if you wish to pay off your home loan faster. You should be regularly exploring your options and making sure your loan is still competitive in the market.
Bonus Recommendation: Be Thorough – Every Little Bit Counts
We’ve hinted at this throughout but it bears repeating: be thorough. If you really want to keep your repayments at a consistently manageable level, you should be exceptionally detailed in exploring your options. If you’re planning to do something like pay off your mortgage in five years, you should be particularly exhaustive in figuring out your savings.
What does that mean? Well, don’t discount things as not making enough of a difference until you’ve actually explored how much they’ll benefit you in the long term. Remember, your home loan is a decades-long commitment. You have time to make small differences work for you.
As an example, some home-owners specifically round up their payments to a nice round figure – say from $481.50 to $500. It’s a dollar difference of maybe ten to twenty dollars – but, paid fortnightly, over ten years, that reduces thousands off of their home loan. Which, in turn, reduces their interest? It also means if interest rates do shift, they’re already ahead of the curve.
And that’s just one small and simple tactic. Think of loose change. Luxuries you can do without. All of that can be used to manage your home loan. Actually do the maths before you write anything off – because every little bit counts. Every little thing can be used to help make your loan a little bit more manageable and get you away from that home loan just a little bit quicker.