Debt is like the leg irons worn by convicts – it holds you back from gaining choice in life, from achieving Financial Autonomy.
Yet if we aspire to own a home, then in all likelihood we’re going to need to take out a very significant loan – a home loan.
So given the conflict between:
a. Our goal here at Financial Autonomy is to help you gain choice in life, and
b. The majority of you will at some point take on a home loan, which potentially limits your choices in life
it makes sense to spend some time exploring how you can get this debt off your back as soon as possible.
In this post we’ll run through the key strategies you can use to get that mortgage done and dusted.
I’m going to start in perhaps a less obvious place. Let’s talk Comparison Rates. In Australia, all lenders must show not only their normal advertised interest rate, but also a comparison rate. Most of the time, you should focus on this comparison rate, as much as the banks would prefer you didn’t.
You see, it will shock you to learn that lenders can be shifty. Whilst the interest rate they charge on your loan would seem to be the main game when it comes to finding the best deal, buried in the fine print will be other fees and charges. Sometimes there’s an annual fee, and very often there is a monthly fee.
So you might have one lender who quotes an interest rate with a $5 monthly fee, and another with a lower interest rate, but a $20 per month fee. The temptation is to just grab the lower rate, however the idea of the comparison rate is to help you make an informed decision.
The comparison rate reflects not just the headline interest rate, but also the fees charged. As such it’s a super useful way to assess one loan against another.
Now the comparison rate isn’t perfect. It assumes a $150,000 loan with a 25 year term. A larger loan amount, which is pretty common, will mean the interest rate is increasingly more important than the fees. But it is better than nothing, and it’s a useful attempt at cutting through the confusion for borrowers like us.
Armed with your understanding of comparison rates, it’s time to shop around. Are you getting a good deal? If you find better deals provided by other lenders, start by going back to the lender that you’re with and asking if they’ll match. Even if they get close, this will be a much easier path than having to move your home loan.
If your current lender won’t budge, talk to the one with the best deal. Do you meet their criteria, and what are the costs associated with switching your loan? You should also check for any exit costs from your current lender.
Understand what you’re getting. Some low rate loans lack important feature like offset accounts and redraw capabilities, or impose inflexibility around early repayment.
Okay, so you’ve gotten yourself the best home loan deal that you can…
Now let’s talk about paying it off
Bottom line – you need to make more repayments.
Because home loans span decades, interest costs really add up. An extra $1,000 paid off the loan in the first year or two could be equivalent you paying $2,000 20 years later.
So get in control of your finances and create a budget. (Check out episode 68 Financial Fundamentals – the 6 essential foundation stones for financial success.) There’s also a great budget tool on the Money Smart web site.
Flowing from your budget will hopefully be savings. Put these in your offset account. If you use a bucket strategy with for instance a bills account and a savings account, you might need multiple offset accounts. Be sure to automate these savings. A strategy of “I’ll see what’s left at the end of the month and pay that off the loan” is likely to result in a less than optimal outcome.
An offset account is a savings account where the amount that sits in there is matched against your home loan, and interest is only charged on your loan for the reduced amount. So if you have a $300,000 loan, and had $50,000 in your offset account, then your home loan would only be charged interest on $250,000.
Putting money in your offset account is like making short term extra loan repayments.
The gain arises because your regular loan repayments remain the same. If the interest charged on the loan is less (because of the money sitting in the offset account), then more of each repayment will come off the principal, accelerating the clearance of your debt.
Can you bump up your repayments? Maybe it’s as simple as rounding it up to the nearest $100.
You want to try and get away from paying minimum repayments as quickly as possible, because at this level, any rise in interest rates will mean your repayments need to step up, and depending on your situation at the time, this could be a stretch.
One way to lift your repayments is to use a pay rise for this purpose. Instead of pocketing the extra cash, adjust your home loan repayments instead. You’ll still have the same money to spend as you always did, but you’ll be saving yourself thousands of dollars in loan interest over the life of your loan.
Next, consider whether monthly loan repayments make sense for you.
Lenders quote repayment amounts as monthly figures. Yet many of us get paid fortnightly. Paying your loan fortnightly instead of monthly can have a big impact, especially if you simply halve the monthly repayment to determine your fortnightly figure.
As an illustration, if you had a $300,000 loan with monthly repayments of $2,500, by simply paying $1,250 per fortnight instead, you cut just over a year off the loan term and save almost $10,000 in interest. (Assumed interest rate is 4.05%).
This result is mainly because whilst there are 12 months in a year, there are 26 fortnights. You end up therefore making one additional monthly payment each year.
Is your loan on interest only? Once upon a time this option was only used for investment loans, but I’ve seen it come up increasingly for normal residential borrowers when prices kept going up and they were stretching to afford a home.
If you have an interest only loan, pause and check that this is still the most suitable arrangement for you. Likely you are paying a higher interest rate, and your loan is not reducing, so your long term interest cost will be huge. The only way such a loan makes financial sense is if you assume the value of the property will go up a lot. It’s a risk.
When looking for ways to turbo charge your home loan repayment be wary of a strategy that sometimes does the rounds whereby you live off your credit card, your wage goes into your home loan, and the credit card gets automatically cleared at the end of each month via a withdrawal from the home loan.
Whilst on paper this strategy can be shown to produce savings, I’ve yet to come across a single person for whom it has worked as planned. The problem is the credit card is a bit of a bottomless pit spending wise. There’s no restraint. I’ve seen instances where people’s debt has actually gone up over the course of a year rather than down. Steer clear would be my advice.
If you want to crunch some numbers there’s a great mortgage calculator on the Money Smart web site.
Well, that’s a wrap for my thoughts on how to get your home loan repaid sooner. I hope you’ve found some useful strategies that you can deploy.
Resources & Links
- How to compare home loans and get the best deal
- Financial Fundamentals – the 6 essential foundation stones for financial success
- Budget Planner
- Mortgage Calculator
- The pay yourself first strategy