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Understanding home loans

How extra repayments could help pay off your loan sooner


2017-11-14 05:30

When you take out a mortgage, 30 years of repayments may feel like a daunting prospect. But take heart. There are some simple strategies that could reduce your loan period and save you thousands of dollars in interest.

Owning your own home can give you a real sense of security. But on the flipside, you might also feel trapped by the prospect of a large debt hanging over your head.

Don’t worry, you’re not alone. Lots of home owners have experienced these mixed emotions. The good news is that many of them have also paid off their loan early and become debt free.

So how do they do it? Here are some common things borrowers can do to get the mortgage off their back and the title deed in their hands sooner.

Make extra repayments

Increasing your monthly repayments could cut the interest charged on your loan and reduce the time it takes to pay off your mortgage.

Interest is charged on the principal amount and in the early years of a loan most of your minimum repayment goes towards paying that interest. Only a small portion of the repayment goes towards the principal amount.

But extra repayments go straight onto the principal. And as the principal gets lower, so does the interest charged on it. In turn as the interest payments get smaller, the portion of your repayments going onto the principal increases.

Generally, fixed rate loans may have restrictions on how much extra you can pay.  However variable interest rate home loans usually allow extra repayments without penalty.

How do extra repayments work?

To see how much interest and time you could save, let’s look at an example.

Scenario 1

  • Sam borrowed $500,000.
  • Sam’s loan period is 30 years.
  • Let’s assume her interest is 5% for the life of the loan.
  • Sam makes the minimum repayment of $2,684 per month.
  • Sam pays approximately $492,000 in interest over the life of the loan.
  • The loan takes 30 years to pay off.

Scenario 2

  • Sam increases her repayments to $3000 per month.
  • Sam saves over $100,000 in interest over the life of the loan.
  • Sam pays off her loan in less than 25 years.

Use offset or redraw

If your home loan has an offset account or redraw facility, these features could help pay off your loan sooner.

An offset account is like a transaction account, but its balance is 100% offset against your mortgage. That means the interest is calculated on your home loan balance less your offset balance. The more money in the offset account, the less interest you pay.

redraw facility lets you pay extra money into your home loan account then withdraw it if you need to. While the money is in your home loan account, it’s reducing your interest. Redraw can give you the peace of mind that although you’ve made extra repayments you can still access the money.

Pay weekly or fortnightly

Most home loans set monthly repayments as a default. But many lenders will let you change to weekly or fortnightly repayments instead.

Because interest is calculated daily, these smaller but more frequent payments could save you interest over the life of your loan.

Put your windfall on the mortgage

If you receive a work bonus, an inheritance or other lump sum, you could consider putting some of this into your home loan.  It might be tempting to book a holiday. But in the long run, reducing your loan period will probably be more relaxing.

As with any large sum, you may wish to consult your financial adviser or accountant before you decide where to put the money.

To sum it up

Things that could help pay off your home loan sooner:

  • Making extra repayments
  • Using offset accounts and/or redraw facilities
  • Paying fortnightly or weekly instead of monthly
  • Putting lump sums into your home loan
How extra repayments could help pay off your loan sooner
Home Loans Specialist

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