Learn about the different options you can take to reduce your home loan
Many borrowers think simply paying monthly or fortnightly repayments will keep them on track, but the truth is that if you're not organised you can still easily end up in debt.
Remember that reducing your home loan quickly will free up your money to pay for other important expenses, invest your money into other assets or simply allow you to reach your financial freedom faster.
Many Australians given the chance would reduce their mortgage, but most often don’t know where to start. We spoke to an expert with over 15 years of experience to find out for you.
- Director at Masters Brokers Group
- Mortgage and Finance Association of Australia (MFAA) Certified Mentor
- Helps mortgage brokers grow highly successful businesses
What's the best way to reduce a mortgage?
‘The best way to reduce a mortgage is to make extra repayments, or make repayments more frequently. For instance, halving your monthly repayment and paying this amount every fortnight is one way to increase the amount and to pay it more frequently. You can also consider changing your mortgage to a cheaper mortgage – but keep making the same repayment amount.’
How can I know what level of budget I need to help manage my payments?
‘It really depends on your lifestyle. The rule of thumb we advise our clients is that if your mortgage repayment is greater than 35% of your gross salary, you may start to experience financial stress. Around 30% - 35% is generally a comfortable amount and you may retain some fun-money. Putting together a budget is also a good way to work out if you can manage your finances and work out how to manage your repayments.’
What is the principal key of mortgage reductions?
‘The principal key for mortgage reduction is to pay more off your mortgage, either by making more payments or increasing the frequency of the repayments. The key is to reduce the principal amount of the mortgage as quickly as possible. Some brokers advocate using a line of credit with a credit card linked to it. Unless you are very disciplined, most mortgage minimisation schemes using a line of credit do not work – as it takes a bit of management to make the most of this. Also they are expensive, as the interest rate on a line of credit is generally higher than a standard mortgage. Unfortunately the secret to paying off your mortgage without discipline or some planning is still a secret.’
How does a mortgage offset account work? Do you recommend using it? Why?
‘A mortgage offset account is a savings account that is linked to your mortgage. The interest on your mortgage is then calculated by deducting (or offsetting) the mortgage amount with the balance in the offset savings account. For instance, if your mortgage is $100,000 and your offset savings has $10,000, then the bank will charge you interest against the $90,000 ($100,000 minus $10,000). Most lenders today have a mortgage offset product.’
Depending on the purpose of your mortgage and the amount of funds you have in the offset account, an offset mortgage facility can save a homeowner interest. For investors, an offset savings account can also allow the borrower to preserve the tax deductibility of the mortgage (if the purpose of the funds were used for investment purposes) and is useful for tax planning. (Speak to your accountant or mortgage broker for more information). We would recommend an offset mortgage to our clients depending on their financial circumstances, goals and purpose.
Options to reduce your home loan repayments
As Andrew mentioned, there are a few proven ways of reducing your home loan. Here’s a bit more about how each strategy can work to minimise your home loan debt.
- Refinancing Refinancing simply involves switching to a cheaper home loan. This may involve a lower interest rate and fees and access to better features. When combined, these can all help to bring the total cost of your loan down. As Andrew mentions, keeping your repayments up even if they become cheaper on the new home loan is one strategy to pay your loan off faster.This effectively means you’re making additional repayments, the benefit of which is explained below.
- Making repayments more frequently One of the oldest tricks in the home loan repayment book is to make repayments fortnightly rather than every month. Making repayments every month means you’ll make 12 repayments per year. Making a repayment every two weeks means you’ll actually make 26 payments (there are 26 fortnights in a year).26 fortnightly payments equates to 13 monthly repayments, which means you’ll be making an extra payment each year, saving interest and shortening your loan term.
- Making larger repayments The above strategies are based on the premise of making larger repayments. The way a principal and interest loan works favours larger repayments. A larger repayment will see more of your money go towards paying off the amount you owe (the principal). The lower the principal, the lower the amount of interest due.
- Making lump sum payments Making a lump sum payment is another way to get a head start on paying your loan off. It’s an extension of the above idea, but rather than making additional repayments regularly, you deposit a large amount towards your home loan early on. This has a greater effect than a regular repayment because you reduce the principal by a greater amount.
- Opening an offset account As Andrew says, an offset account works by reducing the interest you pay on a loan. As we know, interest is what makes paying off a home loan such a lengthy pursuit. Reducing the interest due means you put more of your repayments towards your principal.
- Having a larger deposit Many of the above strategies are based on minimising interest and maximising the amount of payments that go towards your principal. Another way to reduce the amount you borrow is to maximise your deposit when first purchasing a home.
Read on to find out more about each of these methods and how you can employ them to pay off your loan extra fast.