When you begin paying off a mortgage, the first few year’s payments are predominantly made up of interest. In fact, in the first 14 years of a 25 yr P&I loan, you’ll be paying more interest with every payment you make than principal off the loan.
If you can pay a little extra to eat into the principal, then the difference can be significant.
Let’s look again at Grant and Diana. They may be unable to take advantage of Methods 1 and 2 at present, but have chosen to make use of Method 3. However, they would still like to clear their loan faster than the 20yrs 8mths we came up with in the last example.
Every year in August, they receive a combined tax refund for about $2000, and they have chosen to put this directly towards their home loan every year until the loan is paid out. The table below shows the difference this will make.
These calculations are based on the assumption that the interest rate will remain constant over the mortgage term. This is highly unlikely as we have seen in recent times. The method of saving on your mortgage will remain as explained & savings will differ as your you experience different interest rates during the term of your mortgage.
|P&I Loan with Monthly repayments||P&I Loan, Fortnightly repayments + Annual tax refund for $2000|
|Repayment Amount||$1032 p/month||$516 p/fortnight + $2000 per annum|
|Time To Repay Mortgage||25 years||15yrs 10mths|
|Total Interest Payments to the Bank||$159,547||$93,130|
|Total Principal Payments Made||$150,000||$150,000|
|Total Repayments Made||$309,547||$243,130|
|Time Saved||Nil||9yrs 2mths|
By combining methods 3 and 4, Grant and Diana will now save $66,400 in interest and slash over 9 years off their loan.
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In conclusion - Your mortgage need not be forever
You can derive much benefit by using these methods, but you’ll derive maximum benefit if you set targets, write out a plan and budget and monitor it monthly. Be discerning with your expenditure. We suggest using some budgeting software such as the Financial Advisor program (we can help you here)as a basic example. This will also allow you to create and calculate your own mortgage amortization schedule (as we have done for Grant & Diana). Be disciplined – it’ll be worth it.
Here are a few additional tips:
- When restructuring your finances, spend the time to do some research on interest rates and fees across many lenders. Check out the smaller lenders – you may be concerned about their long-term viability, but remember that it’s you that will have their money not the other way around!
- Hidden charges, fees and restrictions usually counterbalance lower advertised interest rates: quite often the lowest interest rate is not the best or most efficient loan.
- Speak to your lender about what financial packages they have on offer. By consolidating your banking with one provider, you may be able to get a fee free home loan, offset account, and credit card, as well as discounted home and car insurance. Over a period of years, ploughing the savings you make into your mortgage could make quite a difference.
- If you think you might be moving, consider a “portable” home loan (such as most Home Equity Loans). You will thereby avoid some fees (which could be discharge costs and establishment fees) when you move as you will be able to use the same loan.
- If you are self-employed or run a business in your own name and are able to, temporarily park the business cash flow in your Offset account or Home Equity Loan until it is needed. This could reduce your loan interest significantly.
- Make sure your finances are structured correctly. Some money spent on good financial advice could well be worth it. For example, if you have investment property in addition to your own home, it’s usually best to put the investment property on an “interest only loan” and plough the saved principal repayments into your “principal and interest” home loan. The interest on an investment property is tax deductible whereas the interest on your own home is not( check with your accountant first). Do all you can to pay off your non-deductible home loan first, and then look at reducing your tax deductible loans. If you’re in the top tax bracket, the difference over time can be quite significant.
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