Did you know that with the average mortgage in Australia, people will spend more money on interest than the purchase price of the home itself?
This article is a 3 step plan on how to slash thousands of dollars and years off your mortgage.
Step 1 – Don’t Over Borrow
I know this is obvious but I see so many people borrowing way too much to buy their family home and the reason they do it is because they don’t see the LONG-TERM sacrifices they will be making.
Borrowing all that money may seem ok now but it’s later on in life (when it’s possibly too late to fix) that they realise they may have made a mistake.
Just remember, the more you borrow and the longer it takes to pay off your home, the less time and money you are putting towards building an investment portfolio.
So really spend time working out how much you are willing to borrow and try to find the right balance.
Step 2 – Extra Repayments
Just because the bank gives you 30 years to pay off your loan, doesn’t mean you should take that long.
I know a lot of people may not be able to afford extra repayments but there are also a lot of people who can make extra repayments but just aren’t doing it.
An extra $50 a week applied on top of the standard repayments of a $300,000, 30 year home loan, could save over $90,000 in interest and take 7 years off the life of that loan.
Look at your expenses and try to come up with ways to cut back your spending without sacrificing your happiness. Then put that extra money towards your home loan.
At the end of this article we will post a link to our free guide on “How to budget without budgeting”.
Step 3 – Know what to look for
When shopping around for a loan it’s important to know what features you need and the ones that you don’t.
You really shouldn’t care about all the bells and whistles the banks usually offer (like honeymoon rates, repayment holidays, etc) because this is where they hide the fat.
In our opinion, all you really need is a basic loan and maybe an offset account depending on what you’re trying to achieve.
An offset account is a separate bank account that is linked to your loan account. The money you have in your offset account is then “offset” against your outstanding loan balance, and you therefore only pay interest on the lower amount.
For example, lets say you had a home loan for $300,000 and an offset account with $50,000 in it. In this example you would only be charged interest on the difference (i.e. $250,000) and you can access the funds in your offset account whenever you like.
Money that has been borrowed for the purposes of buying an investment property is tax deductible debt. On the other hand money borrowed for the purposes of buying a home that you live in is not tax deductible. For this reason, offset accounts can provide potential tax benefits.
For example, let’s say you are borrowing money to buy your first property that you plan to live in, but that property could become an investment property down the track as you might want to buy a bigger family home but keep the first property as an investment.
An offset account can be used to maximise the tax efficiency of your overall debt.
To demonstrate, say we have a young married couple who buy a small unit as their first home for $400,000.
12 years down the track they have just paid off the $400,000 loan, but now they want to upgrade to a bigger home and keep the original unit as an investment property.
The new home cost them $750,000 that they will effectively have to borrow as they are keeping the original home.
If they paid off their original $400,000 loan by putting that money directly into the loan account, their overall debt would be as follows:
- Deductible Investment Property debt = $0
- Non deductible family home debt = $750,000
However, if they were able to pay interest only into the loan account and put all of the principal repayments of $400,000 into the offset account instead, they can now take that $400,000 out of the offset account and use that money from the offset account as a large down payment on the new home.
So now their overall debt would be as follows:
- Deductible Investment Property debt = $400,000
- Non deductible family home debt = $350,000
They still have the same level of debt (i.e. $750,000), but the breakdown is much more tax efficient.
I know that might sound confusing. However, the point is simply that in some circumstances, an offset account can provide great tax benefits.
The downside of an offset account is that some banks will charge a slightly higher interest rate for it. However, there are banks that still offer standard rates for loans with offset.
So, other than a basic loan and maybe an offset account, forget about all the other bells and whistles and just try to focus on getting the best rate. The difference in savings can be quite substantial over the life of the loan.
For example, at the time of writing this the rates advertised by some of the major banks and lenders were more than 0.5% per annum higher than other lenders.
Now that might not sound like a lot but over the life of the loan that extra 0.5% p.a. will have cost over $54,000 more on a $300,000, 25 year home loan.
So that’s it. It isn’t rocket science, but it is effective.
Oh, and here is that link we promised earlier about “how to budget without budgeting“.