Paying off a home loan ahead of schedule can be a smart financial move, especially if you have the means to do so. Not only can this save you tens of thousands of dollars in interest, this will also give you the priceless satisfaction of overcoming your biggest financial hurdle - home ownership.
“There’s little that can replace the peace of mind you get from owning your home outright, reducing the risk of foreclosure during any financial rough patches,” said Mike Roberts, mortgage broker and co-founder of City Creek Mortgage.
Admittedly, it seems easier said than done. After all, home loans are worth hundreds of thousands or even millions of dollars, and taking that financial load off your shoulders would require heavy lifting.
There are proven strategies to achieve mortgage freedom; the key is to determine whether the advantages outweigh the potential drawbacks and if they align with your financial goals and situation.
1. Review your home loan regularly
Despite its long-term nature, you don’t just set and forget mortgages. According to finance expert Dr Lisa Bridgett, reviewing your home loan allows you to check if your rates are competitive.
“Mortgage rates and terms change frequently, and this is outside of what the RBA announces,” she told InfoChoice.
“For instance, if you have an $800,000 mortgage and you are on an interest rate of 6.69% when the best rate in the market is actually 6.09%, that's the difference between you giving $314 per month to the bank and this staying in your pocket,” Dr Bridgett said.
Refinancing to a lower rate while keeping your repayments the same can reduce the total interest paid and the term of your loan, so it also pays to check home loan rate updates regularly.
Dr Bridgett, who is also the founder of NSW-based Stellar Finance Group, highlights the importance of working with a broker to make sure you are getting the better end of the deal.
“By engaging with a broker, you will have someone in your corner to review your interest rate bi-annually to ensure it's still competitive and the best one for you. If it isn't, a broker can facilitate you moving to another lender to ensure you're always getting the best deal, potentially saving you thousands over the life of your loan,” she said.
Regular home loan reviews can also reveal opportunities to restructure your home loan, i.e. splitting your loan or switching from a variable rate to a fixed rate mortgage, or vice versa, whichever is more competitive.
Do note, however, of any potential charges when you make changes to your loan such as break costs, as well as processing and switching fees. Typically, these - barring break fees - could add up to around $1,000, so it pays to look for a lender that minimises onboarding costs.
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2. Make extra repayments or use a redraw
If your lender and your financial circumstances allow, paying more than the minimum repayments can reduce the time you will be saddled with a mortgage debt. You can either add a few hundred dollars to your regular repayments or do it in lump sums when you receive a bonus, a tax return, or any unexpected windfall.
To illustrate how it helps you pay off your loan, an additional $300 on your monthly repayments for a $600,000 home loan with 6% p.a. interest will shave 3 years and 8 months off your 25-year term. And since this extra amount goes directly to your principal, it will lead to more than $96,000 in interest savings.
You can use InfoChoice’s Extra Repayment Calculator to work out your interest savings and loan term reductions.
Even if your budget is a bit stretched, adding a couple of bucks can help you achieve your goal of paying off your loan earlier than the stipulated term.
“The most budget-friendly way to do this is to pay 1/12 extra each month. For example, by paying $975 on a $900 mortgage repayment, you’ll have paid the equivalent of an extra payment by the end of the year,” Mr Roberts said.
On some mortgages you can also opt to make the extra repayments into a redraw facility, which can work to lower mortgage interest payable, but you have the flexibility to withdraw them again if you need.
But before making any changes, make sure your home loan permits extra repayments. Variable-rate mortgages typically allow unlimited additional repayments, while it’s common for those on fixed rates to impose a limit, e.g. $20,000/year.
Other lenders may even charge penalties if you pay more than your minimum, although they are not as common as they used to be. And even if your loan has an additional repayment penalty, Mr Roberts believes “it might still be worth it in the long run to pay off your mortgage early and save on interest”.
To yield favourable results, ensure your interest savings outweigh any potential extra fees.
3. Switch to fortnightly payments
By switching from monthly to fortnightly payments, you essentially make one extra monthly payment each year, according to Ben Baume, co-founder and chief product officer of online intermediary platform Craggle.
“This is because there are 26 fortnights in a year, equating to 13 monthly payments instead of the usual 12,” he said.
This extra repayment goes directly toward reducing the principal of your loan, which in turn leads to a shorter loan term. Many lenders offer flexible repayment options that include fortnightly, monthly, and even weekly frequencies.
“It might not seem like much, but the interest savings on more frequent repayments can cut up to five years from your home loan term,” Mr Baume added.
Before making this change, make sure the payment schedule suits your paydays, and your budget. Making more frequent payments might be easier for those receiving their pay on a weekly or fortnightly basis, while those on monthly pay cycles may need to tweak their budget to accommodate this strategy.
4. Consider a home loan with an offset account
Parking your money in an offset account linked to your mortgage is another easy way to shorten your loan term. An offset account works by offsetting the account balance from the outstanding principal balance, which in turn reduces the amount of interest payable and helps you pay off your mortgage faster.
For example, suppose you took out a $500,000 home loan with a 100% offset account linked to it. If you maintain a balance of $20,000 in said offset account, you will only be charged interest on $480,000.
Important to take note that the money you keep in the offset account does not reduce your principal balance or your repayments, but rather the interest charged. Even so, keeping your money in it could wipe several years off your mortgage life.
Considering that you can easily dip into your offset account, experts such as Loan Market finance broker Beau Cook recommend going as far as treating it as your savings account.
“[Parking your funds in an offset account] means more money in your pocket than leaving [them] in a savings account as you’ll probably be paying more on your home loan than you would earn in a savings account,” he said.
“Put simply, the interest rate on your home loan is always going to be higher than the interest rate of your savings account. So instead of earning 4.5% in interest, save 6.5% in interest charges,” Mr Baume added.
Another reason this strategy may be worth doing is the potential tax savings since you don’t pay tax on interest saved, but you do on interest earned; saving 5% for example, could work out better than earning 5%.
A vital thing to consider, however, is that home loans with an offset account typically have higher interest rates than a standard one, or an extra monthly fee to maintain the account.
You will want to make sure the interest savings outweigh the expenses. This can be done by ensuring you have a sizeable offset account balance.
5. Cut back on unnecessary expenses
Executing most of the strategies mentioned above would require extra funds. Obviously, an unexpected windfall or extra income is key, but another way to ‘earn’ more money to pay off your mortgage early is to reduce your spending.
“Your financial choices have an impact on your bank account, whether you decide to give up pricey coffee drinks, carry your lunch to work, or cut the cable cord. You'd be surprised at how much money you can save by eliminating those little expenses,” said Ian Atkins, financial analyst and contributing editor at The Best Brisbane.
To make sure it’s sustainable, you have to be realistic – make changes to things you can live with. If your daily cup of coffee is something you can’t live without, find ways to save on other things or keep an eye out for discounts and deals.
“Being financially diligent and scrutinising unnecessary costs that reduce expenditure, then coupling this with exploring other income generating activities or enhancing existing investments can help to enable early payment of mortgages,” former Macquarie banker Richard Young said.
This could involve printing out your monthly bank statements and running through them with a highlighter on regular expenses or debits you think you could cut back on. You might be surprised at just how much maintaining four streaming services costs per month, for example.
6. Consolidate your debts
While debt consolidation doesn’t automatically shorten a loan term, it can set the stage for a more strategic approach to mortgage repayment.
“Residential interest rates are typically lower than any other forms of finance. Consolidating debts into your mortgage can lower monthly outgoings by replacing high-interest debts (like credit card debts and personal loans) with a lower mortgage rate,” Dr Bridgett explained.
She continued, “This means you have surplus funds in your pocket to either put towards paying down your mortgage quicker or to cover other lifestyle expenses.”
One way to do this is through a home loan top up. However, despite lower interest rates, home loans have longer terms, meaning more interest is ultimately paid.
Additionally, consolidating debts helps simplify your finances.
“Managing one consolidated payment instead of multiple can reduce stress and the risk of missed payments,” Dr Bridgett said.
What are the benefits of paying off your home loan early?
1. Interest savings
When it comes to mortgage repayments, paying more saves you more – in interest, that is. By working to pay off your mortgage’s principal balance, you can reduce the total amount of interest paid over the life of your loan. This means more cash in your pocket and less worry about rate hikes.
2. Builds equity faster
Every extra repayment goes directly towards your principal balance, so the more you pay it down, the more equity you will have in your property. This can provide you with a substantial resource to meet your other financial goals like securing loans for other investments or ventures.
3. Financial freedom
Nothing beats the feeling of owning your home outright and bidding farewell to your largest financial expense. In addition to reducing your financial stress, paying off your mortgage ahead of schedule can leave you with more disposable income.
What are the drawbacks of paying your home loan early?
1. Loss of liquidity
Since you’re allocating more funds in mortgage repayments, you run the risk of having less cash readily available for emergencies or other outgoing expenses.
Mr Young, who’s also a co-founder of Midkey, an innovative lender that offers ‘no monthly payments’ home loans, warns of the possible impacts of redirecting much of the household’s cash flow onto mortgage repayments.
“When seeking to lower or clear a mortgage early, borrowers should be cognisant that this goal, while realistic in many cases, can spark household and mental stress that may impact their overall well-being, health and relationships,” he said.
If it comes down to life’s essential expenses, or making extra mortgage payments, prioritise the former.
2. Loss of tax benefits
In Australia, interest paid on a mortgage for a property investment is considered an expense incurred and thus tax-deductible. As such, a trade-off for property investors who pay off their home loans is losing the ability to deduct interest payments from their taxable income when negative gearing.
3. Extra repayment penalties
Some lenders charge fees for early repayments, which can potentially offset some of the financial benefits of paying off the loan early. To ensure the pros outweigh the cons, you must have a clear understanding of the terms and conditions of your home loan before making any move.
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