Home loan repayment guide

It makes sense that most people are looking for a way to pay off their home loan more quickly.

For most people, your home loan repayment will be your biggest expense after taxes.

Most people accept the typical 30 year loan term, but a few small adjustments can see the home loan paid off much sooner.

The good news is that these strategies are not overly difficult, and if used correctly, you might not even realise you are making significant inroads to reducing your debt more quickly.

Make sure repayments are not more than 30% of your after tax salary

For most people, their home is their Castle.

It shows the world how successful you are, provides a home for your family and is seen as a cornerstone of financial prosperity.

This is all well and good but it has led to the pretty extreme situation where Australians live in some of the largest and most expensive homes in the world!

As a result, it’s much more difficult for us to repay our mortgages faster because so much of our money is tied up in making home loan repayments. This leaves less surplus cash available for accelerating repayments.

The easiest way to accelerate your home loan repayment is not to go into excessive debt to start with.

As a rule of thumb, I recommend no more than 30% of your after-tax salary is committed to home loan repayments.

Have the biggest deposit possible

Getting your 20% deposit not only proves you have the commitment to repaying your home loan, it also saves you a whopping amount of interest along the way.

Because compounding works in reverse when you take out a loan, reducing the amount of the loan helps you save a considerable amount of interest over the long term.

Consider this - you find a $500,000 property you wish to invest in. Over a 30 year term, you will pay slightly over $359,000 in interest if the interest rate is 4% p.a.

If instead you have a 20% deposit, your loan will reduce to $400,000 and you will pay slightly over $287,000 in interest, a not so insignificant saving of $72,000.

It can also help avoid Lender’s Mortgage Insurance, an additional fee placed upon buyers that do not have sufficient security.

Perhaps it’s not possible for everyone to save a 20% deposit anymore, but you should be saving as much as you can to contribute towards your first house purchase. The benefits are significant.

Make extra repayments on an ongoing basis

Please do not underestimate how much of a difference extra repayments can make, especially when done consistently over the long term.

On a $500,000 loan at 4% interest, just an extra $100 a week of loan repayments can reduce your home loan term by over 7 years and save you over $100,000 in interest.

On the same loan, an extra $200 per week can reduce your home loan term by 12 years and save you over $150,000 in interest.

As time goes on, you will hopefully find that your home loan repayments become easier to afford. This is generally a factor of receiving pay increases at work, or you might find that your kids have finished school or your spouse has gone back to work. When you find you have extra cash, don’t let it sit idle, put it to work and save yourself interest. Money left idle will be eroded by inflation over time, so put the money to use by either investing it or accelerating your home loan repayments.

Make extra lump sum repayments

From time to time, we may find ourselves with an extra bit of cash we didn’t expect.

A work bonus, a tax refund, or maybe a $900 cash injection from the Prime Minister (those were the days!).

Rather than blowing the money on something you didn’t need, instead consider putting the money into your home loan.

A lump sum repayment of $1,000 in the first year can save you over $2,800 of interest over a 30 year loan. Not bad at all.

Extra repayments have the biggest impact at the start of the loan. While debt reduction is beneficial at any time, be mindful that the start of the loan period is when accelerated debt reduction has the biggest impact.

Why?

Because it’s compounding in reverse. Every extra dollar you use to reduce principal now, is now less dollar the bank can charge you interest on in the future.

Don’t make monthly repayments

When you take out a loan, the bank will normally calculate monthly repayments for you.

They do this because they make more money this way.

Because interest accrues daily, you can reduce your interest by bringing forward your repayments.

The easiest way to do this is by making payments more regularly than monthly (i.e. fortnightly or weekly).

Even if you simply changed your monthly repayments to fortnightly, you’d reduce your loan term by over 4 years on a typical 30 year loan.

I go one step further.

When the bank gives you the monthly repayment amount, divide the monthly repayment by two, and then ask for this amount be your fortnightly repayment.

Doing this has several benefits:

• You make half your repayments more regularly, which saves you interest in the long run.
  

• But better yet, because there are 26 fortnights per year, you have effectively paid 13 months worth of repayments in a year. This also helps accelerate debt reduction. You’re welcome.
  

Most people find it easier to make smaller but more frequent payments. The good news is that this is also helps repay loans more quickly.

My suggestion would be to match your repayment cycle to your pay cycle. If you are paid fortnightly, most people find it easier to have the mortgage repayment come out a few days later. If you are paid weekly, you might find it easier to have your mortgage repayment come out weekly.

Just don’t do monthly repayments, you won’t regret it in the loan run.

Hot tip: When negotiating a more regular repayment term, some banks may try charge a fee for making weekly repayments. Avoid this if you can by negotiating for the fee to be waived or using a different bank.

Utilise an offset account

I love offset accounts!

I love them so much I even wrote an article about it. You should go read this article now.

As a quick overview, an offset account does exactly what the name says, it offsets your mortgage. An offset account works exactly like a normal every day account, except that instead of earning interest, it offsets interest charged.

Say you had $10,000 in savings and a $400,000 loan. Instead of charging you interest on your $400,000 loan, your bank will offset your $10,000 in savings against the loan, and only charges you interest on your net debt of $390,000.

Not only does this provide a saving of $400 a year, the savings are reducing non-deductible debt, so it’s a tax free saving.

If all you did was establish an offset account and had $10,000 in it (such as your emergency savings account), you’d save over $20,000 in interest over the life of a loan. Not bad for a days work in getting the offset account set up.

The problem with an offset account is that you might be tempted to spend the money. If you don’t have the discipline not to spend the money in your offset, you might instead make the extra repayments directly to your loan so you aren’t tempted to spend it.

Hot tip: Not every bank allows you to use an offset account, so when you are establishing your new loan, make it a priority to check that offset facilities are available. Offsets tick all the boxes for me - automatic wealth creation, no time and effort involved after the initial set up, and helps you keep your loan clean and non-contaminated if you ever want to convert your home to a rental property.

Use debt effectively:

If you have a deductible investment loan, try not to start making principal repayments on this loan until you have cleared your non-deductible home loan first.

The principal repayments you were making towards your deductible loan can then be used to accelerate your private, home loan debt.

When you pay down principal on a deductible loan, you are reducing future interest deductions. If you have a private loan (where the interest is non-deductible), it makes sense to accelerate the principal repayments on this loan first as you won’t be receiving a tax deduction for any interest earned.

Using this strategy, your debt levels remain the same, you’re just targeting the reduction of non-deductible debt first and utilising your debt more effectively from a tax perspective.

This may take some negotiation or moving banks but it’s a great strategy for accelerating your home loan repayments and increasing your tax refund.

Get the best interest rate you can find:

It probably goes without say, but the interest rate you are charged has a major impact on how quickly you can repay your mortgage.

The lower the rate, the more of your repayments goes towards reducing principal, and the faster your mortgage is repaid.

Just a 1% difference on a $500,000 loan can increase your repayments by an additional $297 per month and increase your interest bill by over $100,000 over the life of the loan. Ouch.

Complacency is not rewarded here.

One frustrating aspect of the finance industry I have found is that the lenders that provide the cheapest rates, do not commonly allow for an offset facility.

For me at least, I value the offset facility more than the lowest rate, but run your own figures to make sure it works for you. The more you have in an offset account, the more valuable this feature will be to you.

Don’t be afraid the switch banks:

Just because you found the best rate to start with, doesn’t mean you still have the best rate.

I have a friend in the mortgage broking business and he always says “The banks are my biggest ally. They are always looking for new customers, but fail to look after their existing customers”.

Essentially, you can often get a better deal by switching banks.

It’s important that you monitor your rate and how this compares with the lending landscape. If you have found that your rate is consistently higher than what’s available elsewhere, give your bank a call and ask if they can sharpen the rate. If not, there won’t be a shortage of banks looking to take care of your business.

So there you have it, my top tips for paying off your home loan faster.

I personally exercised each and every tip here and have reduced my home loan to under 10 years!