How can I pay my loan off faster?

How can I pay my loan off faster?

Whether you have a home loan, a personal loan or a car loan, it’s likely that you’d prefer your debt to be paid off as soon as possible. The longer you owe money to a bank or lender, the more interest you’ll be charged, until the total cost eventually exceeds any benefits offered by the loan.

Here are five tips to help you pay off your loan more quickly, and start enjoying the benefits of a debt-free lifestyle:

Make repayments more frequently

If you currently make loan repayments once per month, consider switching to once per fortnight, or even once per week. Depending on how your lender calculates interest, a larger number of smaller repayments could ultimately pay off more of your loan each year, reducing the principal owing so you’ll be charged less interest in years to come. This could ultimately cost you less in total interest, meaning you pay less for your home or investment property.

Example

According to the ASIC MoneySmart mortgage repayment calculator, a hypothetical $400,000 mortgage paid back monthly in $2000 instalments at 5% interest will be fully paid back in 35 years and 11 months, and ultimately costing $861,835.
Switching to fortnightly payments of $1000 cuts this time down to 29 years and 5 months, and cuts the total cost down to $763,228.

Make larger repayments 

The other way to make a dent in your loan’s principal, reduce your future interest charges, and get out of debt sooner, is to pay more than what’s required each month. As long as you can comfortably afford these larger repayments without stretching your household budget too much, this short term pain could ultimately lead to longer-term benefits.

Example:

Using the previous loan ($400,000 loan, 5% interest, $2000/month) as an example, if you took a long, hard look at your household budget and worked out that you could afford to increase your repayments by 10% to $2200 per month, your loan should be paid off in 28 years and 5 months and cost $749,769.

This tip also works in reverse. If you’re looking at paying back a mortgage over a 30 year term, consider also considering a shorter loan term of 25 years. You’ll need to make higher repayments each month, but you’ll likely pay less in total interest, and be out of debt sooner.

Get a better interest rate, but keep making the same repayments

After a few years of holding a mortgage, you may be able to refinance your loan, either by getting a better deal from your current lender or switching to a new one. Refinancing a home loan can let you enjoy a lower interest rate, which can mean lower minimum monthly loan repayments. While this can save you money each month, and let you put more of your household budget towards enjoying your lifestyle, it may be worth also considering other plans.

If you could comfortably afford your mortgage repayments before refinancing, then sticking to this original repayment plan as if you still had the higher interest rate could get your remaining debt paid off much more quickly, which could in turn bring lifestyle benefits of its own.

Example:
Following on from the original example ($400,000 loan, 5% interest, $2000/month), if you were to switch to a lender offering a 4% interest rate, but continued making $2000 monthly repayments, the loan would be repaid in 27 years and 7 months, and cost $660,265.

Ignore the honeymoon rate

Some lenders offer a low introductory interest rate, AKA honeymoon rate, to new customers. While this low rate is intended to attract new customers with affordable repayments, it’s worth thinking about ignoring this low rate and making your repayments as if the regular non-honeymoon rate was in effect, much like the previous tip.

By making a dent in your loan’s principal early on, you’ll be setting yourself up for lower interest payments later in the loan’s lifespan. Plus, you’ll avoid any rude shocks when your honeymoon rate reverts to the standard interest rate, and your repayments increase with it.

Use an offset account

An offset account is a savings or transaction account that is linked to your home loan, with any funds in the account being included when calculating your loan interest.

Example:
Once you’ve paid back $100,000 of a $400,000 loan, you’ll be charged interest on the $300,000 you still owe. But if also have $50,000 in an offset account, your lender will instead calculate your interest as if you only owed $250,000.

Some borrowers have their wages or salary paid directly into their offset account, and leave as much as possible to accumulate in the account, only spending what they need. This can help to reduce the loan’s interest charges over the long term, meaning the mortgage can ultimately cost less and be paid back sooner.

It’s also important to remember that some offset accounts require you to pay fees or higher interest rates, so consider whether you can realistically afford to keep enough balance in the account for your interest savings to outweigh these extra costs.

Did you find this helpful? Why not share this article?

Advertisement

RateCity

Money Health Newsletter

Subscribe for news, tips and expert opinions to help you make smarter financial decisions

By signing up, you agree to the ratecity.com.au Privacy & Cookies Policy and Terms of Use, Disclaimer & Privacy Policy

Advertisement

Learn more about home loans

What is an interest-only loan? How do I work out interest-only loan repayments?

An ‘interest-only’ loan is a loan where the borrower is only required to pay back the interest on the loan. Typically, banks will only let lenders do this for a fixed period of time – often five years – however some lenders will be happy to extend this.

Interest-only loans are popular with investors who aren’t keen on putting a lot of capital into their investment property. It is also a handy feature for people who need to reduce their mortgage repayments for a short period of time while they are travelling overseas, or taking time off to look after a new family member, for example.

While moving on to interest-only will make your monthly repayments cheaper, ultimately, you will end up paying your bank thousands of dollars extra in interest to make up for the time where you weren’t paying off the principal.

How can I calculate interest on my home loan?

You can calculate the total interest you will pay over the life of your loan by using a mortgage calculator. The calculator will estimate your repayments based on the amount you want to borrow, the interest rate, the length of your loan, whether you are an owner-occupier or an investor and whether you plan to pay ‘principal and interest’ or ‘interest-only’.

If you are buying a new home, the calculator will also help you work out how much you’ll need to pay in stamp duty and other related costs.

How much are repayments on a $250K mortgage?

The exact repayment amount for a $250,000 mortgage will be determined by several factors including your deposit size, interest rate and the type of loan. It is best to use a mortgage calculator to determine your actual repayment size.

For example, the monthly repayments on a $250,000 loan with a 5 per cent interest rate over 30 years will be $1342. For a loan of $300,000 on the same rate and loan term, the monthly repayments will be $1610 and for a $500,000 loan, the monthly repayments will be $2684.

How do I calculate monthly mortgage repayments?

Work out your mortgage repayments using a home loan calculator that takes into account your deposit size, property value and interest rate. This is divided by the loan term you choose (for example, there are 360 months in a 30-year mortgage) to determine the monthly repayments over this time frame.

Over the course of your loan, your monthly repayment amount will be affected by changes to your interest rate, plus any circumstances where you opt to pay interest-only for a period of time, instead of principal and interest.

What happens to my home loan when interest rates rise?

If you are on a variable rate home loan, every so often your rate will be subject to increases and decreases. Rate changes are determined by your lender, not the Reserve Bank of Australia, however often when the RBA changes the cash rate, a number of banks will follow suit, at least to some extent. You can use RateCity cash rate to check how the latest interest rate change affected your mortgage interest rate.

When your rate rises, you will be required to pay your bank more each month in mortgage repayments. Similarly, if your interest rate is cut, then your monthly repayments will decrease. Your lender will notify you of what your new repayments will be, although you can do the calculations yourself, and compare other home loan rates using our mortgage calculator.

There is no way of conclusively predicting when interest rates will go up or down on home loans so if you prefer a more stable approach consider opting for a fixed rate loan.

How can I pay off my home loan faster?

The quickest way to pay off your home loan is to make regular extra contributions in addition to your monthly repayments to pay down the principal as fast as possible. This in turn reduces the amount of interest paid overall and shortens the length of the loan.

Another option may be to increase the frequency of your payments to fortnightly or weekly, rather than monthly, which may then reduce the amount of interest you are charged, depending on how your lender calculates repayments.

What is 'principal and interest'?

‘Principal and interest’ loans are the most common type of home loans on the market. The principal part of the loan is the initial sum lent to the customer and the interest is the money paid on top of this, at the agreed interest rate, until the end of the loan.

By reducing the principal amount, the total of interest charged will also become smaller until eventually the debt is paid off in full.

Who has the best home loan?

Determining who has the ‘best’ home loan really does depend on your own personal circumstances and requirements. It may be tempting to judge a loan merely on the interest rate but there can be added value in the extras on offer, such as offset and redraw facilities, that aren’t available with all low rate loans.

To determine which loan is the best for you, think about whether you would prefer the consistency of a fixed loan or the flexibility and potential benefits of a variable loan. Then determine which features will be necessary throughout the life of your loan. Thirdly, consider how much you are willing to pay in fees for the loan you want. Once you find the perfect combination of these three elements you are on your way to determining the best loan for you. 

What are extra repayments?

Additional payments to your home loan above the minimum monthly instalments, which can help to reduce the loan’s term and remaining payable interest.

What is a fixed home loan?

A fixed rate home loan is a loan where the interest rate is set for a certain amount of time, usually between one and 15 years. The advantage of a fixed rate is that you know exactly how much your repayments will be for the duration of the fixed term. There are some disadvantages to fixing that you need to be aware of. Some products won’t let you make extra repayments, or offer tools such as an offset account to help you reduce your interest, while others will charge a significant break fee if you decide to terminate the loan before the fixed period finishes.

Interest Rate

Your current home loan interest rate. To accurately calculate how much you could save, an accurate interest figure is required. If you are not certain, check your bank statement or log into your mortgage account.

How do I refinance my home loan?

Refinancing your home loan can involve a bit of paperwork but if you are moving on to a lower rate, it can save you thousands of dollars in the long-run. The first step is finding another loan on the market that you think will save you money over time or offer features that your current loan does not have. Once you have selected a couple of loans you are interested in, compare them with your current loan to see if you will save money in the long term on interest rates and fees. Remember to factor in any break fees and set up fees when assessing the cost of switching.

Once you have decided on a new loan it is simply a matter of contacting your existing and future lender to get the new loan set up. Beware that some lenders will revert your loan back to a 25 or 30 year term when you refinance which may mean initial lower repayments but may cost you more in the long run.

How does an offset account work?

An offset account functions as a transaction account that is linked to your home loan. The balance of this account is offset daily against the loan amount and reduces the amount of principal that you pay interest on.

By using an offset account it’s possible to reduce the length of your loan and the total amount of interest payed by thousands of dollars. 

Example: If you have a mortgage of $500,000 but holding an offset account with $50,000, you will only pay interest on $450,000 rather then $500,000.

Does Australia have no cost refinancing?

No Cost Refinancing is an option available in the US where the lender or broker covers your switching costs, such as appraisal fees and settlement costs. Unfortunately, no cost refinancing isn’t available in Australia.