Three ways to pay off your mortgage faster
There is nothing more rewarding than knowing you are on top of your mortgage. Your home, for most people, is likely the biggest purchase you'll make in your life, next to your car.
This has become even more so in recent years. When I bought my first property, the ratio of the cost of my house relative to my junior salary then was five to one.
Today, my niece has to contend with an almost 12 to 1 ratio for an average unit in a suburb in northern Sydney ($920,000) versus her salary as a primary school teacher.
With average property prices likely to hover around $1 million in our big cities, it's become even more compelling to pay off your home loan sooner. Everyone knows that making extra repayments can save you money, but when it's an abstract idea, it kind of floats in the ether and you don't really do anything about it. But if you put it in numbers, the transformative effect of setting extra money aside each week towards your home loan becomes real.
For example, if my niece were to save up 10% to buy her dream unit worth $920,000, she would have to borrow $828,000 from the bank.
Assuming she pays it off over 30 years, her weekly repayment would be $820 (assuming 3.13%pa for principal and interest repayments). Imagine if she finds a way to set aside $50 each week as an extra repayment. She would be able to pay off her home loan two years and nine months sooner and save $47,056 in interest.
If you are a first-time buyer, or even someone who has yet to take the plunge into property investing, you could benefit from a few tips on how to pay off your loan faster. Here are three to get you started.
1. Shop around
No, really, shop around.
The big four banks - CBA, Westpac, ANZ and NAB - all have a great section on their websites for prospective home loan borrowers. You can play various lending scenarios through their easy-to-use calculators. The repayment calculator can tell you how much you need to set aside each week if you want to borrow,
for example, $800,000 or $820,000.
You'd be surprised how different the interest rate offers are. But Susan Mitchell, chief executive of the broker Mortgage Choice, says the differences could narrow once you've spoken to the bank.
"The challenge with the major banks is that they have a carded rate, but behind the scenes they discount based on a client's circumstances," she says.
For example, if the client is a professional, like a lawyer or a doctor, the client could sit down with the lender to negotiate a better deal. Alternatively, if you're working with a mortgage broker, the broker could request a discount. "You may find that the interest rate on these loans would not be so dissimilar."
Banks might also offer a lower price if they want to attract a certain type of business to balance their portfolios. For example, if they want to increase the size of their investment lending portfolio, they could offer more competitive rates for customers who qualify.
But you won't know what is really on offer until you do some legwork, which, unfortunately, not everyone does.
2. When a "comparison rate" does not apply to your situation
When you compare home loans, it seems logical to calculate the cost of borrowing based on the interest rate the institution is offering. But have you ever wondered why there's a larger percentage value quoted along with the "comparison rate"?
That's because the real cost of the loan isn't just the interest rate but other fees and charges as well, including the application fee and ongoing fees.
What can be confusing, or even misleading, is that comparison rates are often calculated on a $150,000 home loan over a 25-year term.
"This is not a common scenario. The average loan size is closer to $400,000," says Mitchell.
It's even more misleading for my niece who is looking to apply for more than double that amount.
3. Do you need an offset account or redraw facility?
Assuming my niece took up a home loan package that had a lower interest rate but an annual fee of $400, that's another $12,000 over 30 years, excluding interest.
"Generally speaking, it is cheaper to get a home loan that isn't packaged," says Mitchell. But this also means the borrower will not be able to access features such as an offset account or redraw facility. So, you have to assess if you need those features.
You can always refinance or switch loans when your situation changes and you need the extra flexibility of a package.
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