When you sign up for a home loan, you usually sign up to a term of 25 or 30 years.
But does it really take that long to pay off a mortgage? And, if not, what tactics can you use to pay yours off sooner?
The starting point: A mortgage repayment calculator
While many people opt to take out a 30-year home loan, a repayment calculator is a great tool for estimating how much more or less you may have to pay each month, week or fortnight depending on the term of your loan. For instance, you can get an idea of what you might pay if you bring your home loan down to 25 or even 20 years.
The effect of a shorter or longer term on your home loan
Shortening the length of the term of your loan can be an effective way to become mortgage-free sooner. However, the shorter the length of your mortgage, generally the more you repay each month and the less you will be able to borrow.
Conversely, the longer your home loan, generally the lower your repayments will be and the easier it should be for you to meet your minimum monthly repayments without compromising your lifestyle.
An example
Say, for instance, you buy a property worth $800,000 with a home loan of $640,000. If you were to borrow this amount over 30 years and the interest rate was 4%, your monthly repayments would be $3,055 a month. If you were to borrow the same amount over 25 years with an interest rate of 4%, your minimum monthly repayments would be $3,378 a month. Finally, if you were to borrow $640,000 over 20 years at an interest rate of 4%, your monthly repayments would rise to $3,878 a month. All of the examples above assume no other fees or charges are payable and the interest rate remains the same over the term of the loan.
How making extra mortgage repayments can reduce the life of your loan
Regardless of the term of your home loan, you don’t necessarily have to allow it to run its full course. You can often choose to pay it off early – especially if you have a variable rate home loan. In the process, you’ll reduce the overall cost of the loan.
One effective way to reduce the amount of your loan can be to make extra repayments each month. After all, the amount you’re required to pay each month is simply a minimum repayment.
Making extra repayments is especially effective in the early stages of a home loan – say the first five to 10 years. That’s because, in most home loans, much of the cost of your early minimum repayments goes into paying interest rather than the principal of the loan. Making extra repayments early on, and paying down principal as well as interest, will have compounding effects over the whole life of your loan.
Adjusting your repayment cycle
Another way to reduce the life of your loan without noticing it too much could be to adjust your repayment cycle. One way to do this could be to adjust your repayments so that they’re in line with when your salary is paid. For instance, if you receive your salary fortnightly, you could pay half the amount of your monthly repayment every two weeks, so that you’d effectively make 13 monthly repayments a year. Another way may be to operate on a four-weekly rather than monthly cycle. Again, that way you’d effectively make an extra monthly repayment every year.
Using an offset account or redraw facility
An offset account or redraw facility can also be a great way to reduce the term of your home loan. As its name implies, an offset account offsets the interest on your mortgage so that you only pay interest on the balance. For instance, if you have a home loan of $200,000 and there is $50,000 in your offset account, you will only pay interest on $150,000. Because the amount of your contribution doesn’t change, you’ll be paying off the principal on your home loan.
In other words, you might sign up for a 30 or 25-year loan but it doesn’t have to take that long to pay it off. If you make extra repayments, use an offset account or redraw facility, or structure your repayments cycle differently, you may be able to become mortgage-free much sooner than you think.
Want to know more?
To better understand your borrowing options please contact Elite Finance Professionals on 0437 404 445, for an obligation-free assessment of your situation.