Understanding Home Loan Repayment Options
Tuesday, May 6, 2014
Typically, a home loan repayment schedule is expected to stretch over thirty years. However, many home buyers and investors prefer to try and pay off their home loan sooner – either to simply get out of debt or to put them in a better position for future investments.
If you’re one of those interested in paying off your mortgage sooner, great – but first it’s important to understand the fundamental home loan repayment options in place.
Principal and Interest
Principal and Interest (or P&I) is the standard repayment model. It involves regular payments of a percentage of both the amount of money borrowed (minimum repayment amount) and its interest (interest charges) until you’ve paid off your loan. In order to pay off your home loan sooner through a Principal & Interest loan, you’ll need to make higher average repayments than is required by your loan. Bear in mind; some loans will be harder than others to pay off in this way.
(Fixed Interest Rate loans, for example, do not generally allow an excess of early repayments. If you do wish to pay off your fixed interest rate loan sooner, you’ll need to pay an Interest Adjustment Fee. This is because a bank has loaned money to you on a fixed or ‘certain’ expectation of a return. Variable Interest Rate loans, by contrast, allow more flexibility in regards to repayment – but they have limits as well.)
Interest Only (or I/O) is a repayment model where your regular repayments keep at bay only the interest owing on your loan. This home loan repayment method allows you to pay off the principal amount at the end of the loan contract. This is a popular option for investors. For example, an investor may purchase an investment property, put the rent (the income he's earning from the property) towards his I/O repayments and then sell the property later at a higher price to pay off the principal amount of his loan.
There are other approaches – strategies, budgets, wads of cash - that can effectively help to pay off your home loan sooner. An offset account, however, is among the most powerful. An offset account is a feature available to some home loans which allows you to link a savings account to help ‘offset’ the interest you’re paying on your home loan. Whatever money is in that account is counted as an amount less which you then have to pay interest on. If you have a $250,000 home loan, for example, and $50,000 in your offset account, you’ll only have to pay interest on a $200,000 loan. With a lower sum on which to pay interest, you’re in a much better position to pay off your loan sooner.