Your home mortgage is one of the largest financial commitments you will make in your life and you if you’re like many Australians, you will probably have to work for 20 to 30 years to pay it off. If you could be free of your mortgage earlier, it would undoubtedly be a great relief. There are a few strategies people use to pay off their debt a little faster.
Why do people use mortgage reduction strategies?
As you repay the principal that you have borrowed on your home loan, your interest costs come down. As a result, the total interest you end up paying on your mortgage may be significantly lower if you pay off larger amounts at a time.
Let's assume you borrow $500,000 at 4 per cent interest for 25 years. Using a mortgage calculator, your monthly repayment would be approximately $2640, and the total interest you would pay the bank is over $291,000. If you chose to repay the loan in 20 years instead of 25, your monthly repayment would go up to $3030. However, your total interest would reduce to approximately $227,000. Under this modelling, you could save about $64,000 by paying off your mortgage five years sooner.
An additional advantage of repaying your home loan sooner is that you then have more equity in your home, which you can access to make investments that could generate returns or meet expenses.
What mortgage reduction strategies can I use?
If you’ve decided you’d like to be free of your mortgage sooner, there are a number of ways to go about it. It’s important to make sure they are within your budget though and won’t cause additional financial stress. If in doubt, seek advice. If you do go down the path of mortgage reduction strategies, here are some of the more popular ones:
- Avoid interest-only loans. You may be tempted to go for an interest-only loan as your monthly payments in the initial years will be more affordable than with a principal-and-interest loan. However, once the interest-only period ends, you will need to start repaying the principal amount and your monthly repayment will be substantially higher. You also won’t be tackling the principal for the interest-only years.
- Pay fortnightly instead of monthly. You may be surprised to know that you may save on interest if you choose to repay fortnightly instead of monthly. Interest is calculated daily on the balance you owe, and more frequent repayments reduce the interest amount. Also, there are 52 weeks and 26 fortnights in the year, so you repay the equivalent of 13 monthly instalments, which may help to end your loan faster. A home loan calculator can help you to see how fortnightly repayments save you interest.
- Use an offset account. Check whether your lender offers the offset account feature with your home loan. An offset account is a bank account linked to your home loan. When interest is calculated, the funds in the offset account are reduced from the home loan balance. This reduces your interest burden while keeping funds accessible if you ever need to use them.
- Salary sacrifice your home loan. Check whether your employer and lender will allow you to set up a salary sacrifice into your home loan. This could reduce your tax burden, and you may be able to use the savings to repay your mortgage faster.
- Consolidate debt. If you have a home loan and a personal loan, you are paying a higher interest rate on the personal loan, which leaves you with less money to repay your mortgage. Refinancing a home loan and consolidating debts could lead to a reduction in interest costs.