I’m like a builder without a finished home, the hairdresser without a great cut and the finance expert who could do with spending more time on her finances.
Often I’m so busy with work that I neglect my personal affairs, and this has cost me money.
Some time ago I looked into our loans and realised that we had outgrown our existing mortgage. Don’t get me wrong: for some time it was perfect. I got the 0.8 per cent discount off an already competitive rate, and it had all the bells and whistles we needed while we were renovating.
But now I’m paying an annual fee of $395 for the privilege of having a whole lot of products and features that I don’t use.
Without even having to refinance I could be on a much better rate simply by asking my lender to swap my loan to a basic one (no offset, just redraw, which suits us fine). It was only as I was writing this chapter that I realised I hadn’t gotten around to doing this.
I kick myself now because in less than 15 minutes I managed to get an overall discount of 1.25 per cent off the standard variable rate. Why, oh, why didn’t I make this call earlier?
It’s great to own your own home — but if you take 25 or 30 years to pay it off, the interest will be a killer.
Borrow $400,000 at 4 per cent and make no extra repayments and you’ll pay a whopping $233,000 in interest over the 25-year loan. And that 4 per cent is a conservative figure — if rates were, say, 6 per cent you’d fork out $373,000 in interest.
So getting rid of your mortgage quickly is definitely in your best interests.
Here are my top tips for getting your mortgage off your back faster
KNOW HOW MORTGAGES WORK
The important thing to understand about home loans is that interest is calculated on the daily balance and charged to the loan account monthly in arrears. Take advantage of this fact. If you can reduce the daily balance, even by just a few dollars, you will save in the long run on both interest paid and the term of your loan.
In dollar terms: Let’s say you have a $500,000 home loan at 6 per cent, where interest is calculated on the daily balance and charged monthly in arrears.
Over a 25-year term your repayments would be $3222 a month. If you make no repayments until the end of January, interest will be calculated each day on a $500,000 balance. Since there are 31 days in January, a total of $2547 in interest would be charged at the end of that month.
Had you made half of your monthly payments on January 15, for example, and the remainder at the end of the month, you would have saved $3.29 in interest at the end of January, which means that an extra $3.29 could have gone towards the principal. The savings may be small but over the long run this will reduce your term and cut a substantial amount off the total interest payable.
When it comes to slashing your interest bill by a good $86,000 or so, there is no better strategy (and it’s easy too) than paying fortnightly.
To get these savings you need to halve the minimum monthly repayment and pay that amount every two weeks. That’s because there are 26 fortnights in a year — the equivalent of 13 monthly repayments rather than 12.
For those borrowers who divide their minimum monthly repayment by four and pay weekly, the savings are slightly higher still on interest but not so much on the term. It’s important to note here that some lenders, when calculating fortnightly payments, multiply the monthly repayments by 12 and then divide it by 26 to give you a fortnightly amount. While this is correct, it will not reduce your home loan as quickly.
The next best thing to fortnightly repayments are extra repayments. It’s the only strategy that can reverse the effects of compound interest in the early years of your loan.
There’s a simple reason why after the first couple of years you still owe pretty much what you borrowed — only a fraction of your repayments go towards the principal. The rest pay off the interest.
On a $500,000 mortgage at 6 per cent over 25 years your monthly repayments would be $3222 and you’d pay over $466,000 in interest. Round up your repayments to $3300 — so an extra $78 a month — and you’d save nearly $29,000 in interest.
Better still, make fortnightly repayments of $1650 and the savings jump to over $106,000.
MAKE ONE-OFF CONTRIBUTIONS
Even if you can’t afford to make additional repayments, one-off lump sum deposits such as a tax refund or a small windfall can have a surprising impact.
In dollar terms, a lump-sum payment of, say, $1500 in the third year of a $500,000 home loan at 6 per cent could cut your term by two months and save you more than $4000 in interest.
Why not deposit your tax refund into your mortgage every year? You’ll never miss what you never had.
USE YOUR SAVINGS TO REDUCE INTEREST
Make sure your home loan has redraw or offset. Both reduce the interest you pay but offset is a little more versatile.
An offset is a transaction account that’s linked to your home loan. The money you have in this account offsets the amount you owe, and you’ll only be charged the interest on the difference. And because no interest is paid to the offset account (as less interest is charged to your loan account), you pay no tax on the savings interest.
You can link your offset account to a debit and/or credit card. You can speed things up by living off your credit card. The idea is that on payday your salary goes into your offset account. You use your credit card for living expenses, taking advantage of the interest-free period. During this time your salary is cutting your home loan interest bill. This strategy only works if you repay your credit card before the interest-free days end.
A redraw facility sits inside your home loan, so it’s not a separate account that can be linked to a debt or credit card. Redraw can also have some restrictions: For example, your lender can turn off the facility if your situation changes.
Redraw fees and a maximum and minimum for redraws can also apply. In dollar terms, $5000 sitting in either a redraw or offset account would save you over $17,000 in interest on a $500,000 loan at 6 per cent over 25 years.
GET THE BEST DEAL
Do you even know what rate you’re paying on your mortgage? A Mortgage Choice survey found that two in five Australians don’t know their current home loan interest rate. Make sure that you’re not one of those 40 per cent of Aussies.
Find out exactly what rate you’re paying and then see if you can find a better deal. Comparison sites like canstar.com.au, ratecity.com.au, mozo.com.au and finder.com.au are a good way to check out what’s on offer, or you could use a mortgage broker.
If you do find a better deal, though, don’t rush to switch. Ask your current lender if they can beat or match that rate, and you can save yourself the hassle of switching.
If your lender won’t come to the party with a cheaper rate, make sure you do a break-even analysis before refinancing. Add up all the costs of moving (your new lender may request a valuation fee and may also charge you an establishment fee) and divide this by your monthly savings.
If, for example, it costs you $1000 to move but you would save $50 a month in repayments, your break-even cost is 20 months, meaning it will take you just under two years to recoup the cost of moving.
You also need to ask yourself whether you can be certain that your new lender will be just as competitive then as it is today.
Even if you do refinance to a loan with a lower rate, you should keep your repayments at the level you were paying for the more expensive loan, and you’ll save even more.
So let’s say you had a $500,000 home loan at 4.5 per cent per annum. Your repayments would be $2779 a month, and you’d pay $333,748 in interest. You refinance to a loan at 4 per cent and your repayments would be $2639 a month, with $291,755 in interest — a saving of nearly $42,000. Stick to paying the $2779 a month you were paying on the 4.5 per cent loan and you’d save a further $27,000.
SHOULD YOU LOCK IN?
It’s a question I get a lot: “Should I fix my home loan?” If you are worried about how you’d cope if rates increased, then it can certainly be tempting.
If you do opt for a fixed loan just make sure it’s flexible. More and more fixed loans are flexible these days, allowing extra repayments, while some even have redraw and offset. Some of the key questions to ask are:
• Can you make additional repayments during the fixed term, and if so, what is the maximum?
• Will you receive a “package discount” on the fixed portion of your home loan?
• Can you offset the fixed interest charged against savings?
• Can you lock in the advertised fixed rate when you first apply for your loan?
If you really want to maximise the extra repayments you can make without being penalised, then split your fixed loan into two or even three accounts.
This way you double or triple the amount of your penalty-free allowance.
The ultimate price you pay for certainty is if, for whatever reason, you need to break your contract, you will pay.
If you’re uncertain you may want to hedge your bets by fixing only part of the loan and leaving the rest variable.
This is an extract from A Real Girl’s Guide To Money by Effie Zahos, RRP $24.99, Bauer Media Books.