A mortgage is the biggest debt most people will ever have in their lives. The majority of home owners spend their entire lives paying off their home loan, which usually includes the amount borrowed, plus bank interest totalling as much as the loan itself.
A $500,000 loan over 30 years from one of the major banks will cost you $988,560. That’s an additional $488,560, and that’s with a 5.2% interest rate, which is considerably low at the moment. If (and when) rates go up, the interest paid over the course of the loan will be even higher!
So how do you pay off your home loan quicker, and more importantly, stop paying the banks all that interest?
Reduce the term of the loan
This seems obvious but most people don’t do it! Firstly, because the banks suggest a 30 year period, which consumers naturally go ahead with. Secondly, because reducing the term of the loan means you have to pay more each month.
On that $500,000 loan, you’re paying $2746 per month over 30 years. And $488,560 in interest.
Switch it to 25 years, and you’re paying $2982 per month. But only $394,6000 in interest.
That’s almost $94,000 less in interest by paying a bit extra off the principal each month.
Before going any further, we should stress the importance of shopping around for the best rate. Finding the most competitive deal for your circumstances will allow you to maximise savings. And don’t just look at upfront benefits, the total costs over the course of the loan is where your attention should be. Comparing multiple lenders can be done through a company such as Best Loans First or Rate City.
Increase your payment frequency
Again, the banks by default require you to pay off your mortgage once a month. Why? Because it’s better for them. Paying fortnightly saves you a lot in interest.
As there are more than 28 days most months, paying fortnightly actually means you’ll pay more off the loan, which over 30 years, adds up!
$500,000 over 30 years paying monthly = $2746/month = $488,560 total interest.
$500,000 over 30 years paying fortnightly = $1373/fortnight = $395,524 total interest.
That’s a saving of $93,000 in interest by paying fortnightly instead of monthly.
Both these options are great ways to save money by reducing interest charges. So what if you combine them both?
$500,000 over 25 years paying fortnightly = $1491/fortnight = $328,899 total interest.
Nearly $160,000 less than paying monthly over 30 years! It may take a little bit extra discipline on your behalf, but it’s worth it!
An offset account and credit card are your friends
This next tip requires you to be ultra disciplined, but if you can be, will result in even more savings. In fact, this technique has seen some people pay off their home loans in under 10 years, saving hundreds of thousands in interest charges.
An offset account is a transaction account linked to your home loan. Any money in the account “offsets” the interest charged on your mortgage. For example, if you have a $400,000 loan and $20,000 sitting in the offset account, you’re only paying interest on $380,000.
So basically, the more money you have in the account, the more interest you can avoid paying on your home loan. Hence, it makes sense to have ALL your day to day money and savings in your offset account. But there are even better tips to reduce interest.
Pay for everything on credit card
When I say everything I mean everything. Not just online purchases but groceries, bills, petrol, everything you buy, put it on the credit card. This may seem silly on the surface but it will save you a LOT of money.
Most credit cards have 45-60 day interest free period. So as long as you pay the full amount off each period, you will not pay interest. And all this time, the money you WOULD have spent from your transaction account, is still in their, “offsetting” the mortgage and saving you interest.
If you spend $4000 a month on food, petrol, entertainment, bills, clothing and all other expenses, putting it all on your credit card will mean you have an additional $4000 sitting in your offset account, reducing the amount on your loan which you’re paying interest on. Yes you have to pay your card off each month, and then that money will disappear from the offset account. But think of all the time that extra money IS in the account, and think of it happening 12 months a year, for the life of your loan.
All of a sudden you’re saving a tonne in interest! And you will be paying down the principal quicker, meaning your mortgage will be paid off sooner!
Business owners and sole traders tips
If you own a business, there are other ways to pay off your home loan faster. Firstly, ensure your clients are paying directly into your offset account. Pay suppliers and other expenses right on the due date rather than early. The more time the money spends in your offset account, the better.
If you collect GST, organise to pay it back yearly rather than monthly. Holding it as long as possible in your account will further reduce your home loan interest charges. But don’t forget, it’s the ATO’s money, and does have to be paid back eventually, so keep a record of just how much is theirs!
The same with paying tax. If you have a PAYG structure and pay quarterly, wait until the last possible moment to pay your installment. Depending on how successful your business is, it could be tens of thousands of dollars. So you’d be stupid not to keep it in the offset account as long as legally possible.
Hopefully you find these tips all helpful in reaching financial freedom, or at the very least saving you a bit of money. And the best part is, you’re doing it at the expense of the banks, credit card companies, and ATO. How sweet is that!