By making extra home loan repayments and shrinking your home loan principal, you can reduce the interest you are charged on your mortgage. This could give you the choice between taking steps to pay off your property sooner, or adding some breathing room to your household budget.
How do extra repayments work?
Many home loans involve making regular principal and interest (P&I) repayments, where each month, fortnight or week, you pay back a small amount of the money owing on your home loan (the mortgage principal) as well as an interest charge. Over the loan term (often 20-30 years), you’ll slowly but surely pay off your mortgage.
However, this regular repayment is often the minimum amount required by the lender. Many lenders will allow you to put more money towards your home loan, whether you’re regularly paying more than the minimum amount, or adding the occasional one-off lump sum when you can afford it, such as when you get a tax refund. Lenders may allow you to make unlimited extra repayments, or they may cap how much extra you can pay onto your mortgage each year.
Any extra repayments you make go straight towards paying down your home loan’s principal. Because the interest charged on each home loan repayment is calculated based on your remaining home loan principal, the further ahead you can get on your home loan, the less interest you may be charged on each repayment.
How can extra repayments save me money?
There are two ways that making extra repayments on your home loan can potentially save you money.
One is that if you’re being charged less interest on your home loan, you may be able to reduce your monthly mortgage repayments. This can help to free up some breathing room in your household budget, which may be welcome in households at risk of facing financial stress.
Secondly, if you keep making the same repayments even after your interest charges are reduced, you can pay off your home loan principal faster. Not only can this help further shrink your interest charges, but you may pay off your property sooner, and pay less interest over the long term.
What else should I know about extra repayments?
Keep in mind that even if you make enough extra repayments to lower your interest charges, many lenders will automatically keep your home loan repayments the same unless you specifically ask for them to be lowered. This means that you’ll pay the same amount each month, but a greater percentage will go towards reducing your mortgage principal, and less will go towards covering interest charges.
It's also worth remembering that the more money you can put into your home loan, the faster you can potentially build your equity in the property. Combined with capital growth if your property’s value increases, your equity could allow you to more easily refinance to a home loan offering a lower interest rate, or to secure other financial products, such as a line of credit.
Before putting together a money-saving strategy that involves making extra repayments, it may be worth consulting a financial expert such a mortgage broker to learn more about if this will be the best option for your specific financial situation.