When you take out a home loan, you’re not just committed to repaying the initial cost of your new home. You’ll also have to pay the interest calculated on your loan balance each month. Over the term of your loan, this can translate into hundreds of thousands of dollars in addition to your principal amount. One proactive way you can reduce the total amount of interest you’ll pay – and repay your debt faster – is by making extra repayments to your home loan.
By paying extra, you can shave years off your loan term, shrink your total interest owed by tens of thousands of dollars, and potentially give yourself some extra financial flexibility, in case you need to access the extra funds you've paid towards your home loan in the future.
If making extra repayments sounds too good to be true, it’s not. It is, however, a financial habit that’s too worthwhile to ignore. Here’s how it works.
You can make extra repayments in a couple of different ways.
Your loan will require a monthly repayment, but by paying half of your monthly repayment each fortnight, you’ll make the equivalent of one extra month’s repayment in the year. The reason is that there are 12 months in a year, but 26 fortnights.
Another way is to take a look at your budget to see where you could cut down your lifestyle expenses, and then divert a little more of your income towards your mortgage repayment.
Do you think you're not in a position to cut down your expenses enough to add an additional $100 or $200 to your home loan each month? Think again. A couple of simple lifestyle changes like cutting your grocery bill by $20 a week and eating out less can easily leave you with extra money. The long-term benefits of making a few small changes now are definitely worthwhile.
Let's start by looking at a home loan extra repayment calculator. With a $400,000 home loan with a 30 year term and a 3.99% interest rate*, your total interest payable would add up to $286,648. By adding just $150 to your repayment amount each month, going from $1,907 to $2,057, you’d save $42,222 in interest over the loan term. And, your loan would be paid off three years and ten months earlier!
Another way to make extra repayments is to pay a lump sum whenever you have extra money. Maybe you get a bonus every year from work, or a good tax return, and can use this to pay down your mortgage faster. For example, if you're able to manage to make a lump sum payment of $6,000 in the fourth year of your loan on that same $400,000 loan at a 3.99% rate, you’d save $10,685 in interest over the loan term. On top of this, you’d pay off your mortgage eight months faster - and that's with just one additional payment of $6,000! Make lump sum payments when you can over the years and pay a little extra each month and the sky's the limit when it comes to how much you can save.
You can try out a home loan extra repayment calculator yourself to find out how much you could save by paying a little extra each month, lump sums, or both.
If you make extra repayments to your home loan, you won’t just save money and give yourself more months (or years) to enjoy life mortgage-free, you’ll also gain more financial breathing room. If your home loan product includes a free redraw facility, you can withdraw the extra funds you’ve paid if you ever need them. This takes away some of the risks of devoting extra funds to paying down your home loan, rather than putting money into a separate savings account. You’ll benefit from a smaller interest burden on your mortgage but you can still access your money if you need it.
This can also be a great financial habit if you’re not typically disciplined with your savings. Your lender may require you to get approval for every redraw, which means you’ll have to take an extra step to get your money – and this way you could be less likely to use it for frivolous spending.
As you pay down your home loan, you’ll also build up more equity. This can come in handy if you plan on investing in a second property in the future.
If you have a fixed rate loan, you may not be able to pay extra towards it without having to pay a fee, and depending on the details of your home loan product, you may have limits on how much extra you can pay each year. Contact your bank to find out the details of your loan before making any extra repayments so you don’t incur any penalties or fees.
When it comes to putting additional funds towards your home loan, choose what works best with your lifestyle. Whether you can devote more of your income each pay cycle or you’d prefer to use any extra cash you earn, save, or come into as a lump sum payment, every extra dollar you put towards your loan helps.
In the first few years of your loan, most of your repayment amount goes toward interest as the principal is still large, so the more you can pay off earlier on, the more impact you’ll make. Start making extra repayments early on and your future self will thank you!
*Rate calculate based on the rate offered as at 12/04/2019 and is subject to change.
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