A key financial goal for most people is to eventually repay their home loan. Last year I outlined 3 questions you must ask yourself to determine whether repaying your home loan is your top priority – see here.
The internet is filled with countless ideas on how to repay your home loan faster. However, many of these tips tend to be relatively ineffective. In essence, there are only 3 to 4 truly impactful methods to accelerate the repayment of your home loan.
(1) Minimise the cost of debt
You must ensure your interest rate is as low as possible. Don’t ever feel like you need to be loyal to your bank, because they are certainly not loyal to you. They always offer better deals to new customers. Consequently, existing customers end up paying a loyalty tax.
A one basis point (0.01%) interest rate reduction will save you $50 per year for every $500,000 you borrow. Therefore, depending on your loan size, you don’t need to agonise over relatively small interest rate differentials if your home loan size is small.
Interest rate discounts are influenced by various factors like the bank’s retention strategy, individual loan amounts, total lending, loan-to-value ratio (LVR), repayment type, and whether it’s a home or investment loan. To leverage these factors, consider actions like requesting your bank or mortgage broker to revalue your property to reset the LVR. If possible, consolidate mortgage accounts, whilst keeping debt related to different assets in separate accounts. Switching from interest-only to principal and interest repayments will reduce your interest rate. Approach your bank, especially during periods of heightened customer retention focus, to negotiate higher discounts with the awareness of your broker.
A good mortgage broker will do all this work for you and will work hard to retain your business.
(2) Offset, repayments and cash flow management
Having an offset account linked to your mortgage is crucial. Once established, the frequency of your mortgage repayments – whether weekly, fortnightly, or monthly – becomes inconsequential, as funds in your offset account save you interest. While some banks historically halved the monthly repayment to calculate the fortnightly amount, equating to 13 monthly payments annually (since there are 26 fortnights), not all banks follow this method. Nevertheless, the destination of these additional repayments – whether directed to your home loan or left in the offset account – does not impact their effectiveness. The key is the presence of an offset account for interest savings.
Repaying your home loan faster simply requires you to direct as much money into repaying your home loan as soon as possible. It’s that simple.
Additional mortgage repayments provide compounding savings.
For example, if you make one lump sum repayment of $50,000 into a $1 million home loan, it will save you almost $240,000 in interest over the life of the loan and repay the loan almost 4 years earlier.
Similarly, making regular extra repayments is also very powerful. For example, repaying an additional $500 per fortnight on a $1 million loan will save over $470,000 in interest over the life of the loan and repay the loan over 9 years faster.
Once more, it’s important to emphasise that the method of directing additional repayments -whether directly into your home loan or into your offset account – does not affect the outcome. Some borrowers prefer to deposit surplus funds into the home loan directly, as it tends to be less tempting to spend.
How can you afford to make these extra repayments?
It’s simple. Start by monitoring your discretionary spending on a weekly, fortnightly, or monthly basis. Without tracking, spending tends to rise, limiting your ability to make extra home loan repayments. Focus on avoiding expenses that don’t enhance your standard of living. Setting a conscious limit for total discretionary spending allows you to identify and correct any budget exceedance. The best way to do this is to maintain separate accounts for non-discretionary and discretionary expenses, as explained here. This improves your financial management.
(3) Make sure you have a Plan B
Your primary home loan repayment strategy, Plan A, should involve securing the lowest interest rate and channeling as much cash flow directly into your loan or offset as possible.
However, it’s crucial to have a Plan B in case your cash flow falls short of repaying your mortgage in full. What your Plan B strategies involve depends on your circumstances. However, some examples include:
- Downsizing your home. It’s important to approach this strategy with caution. While individuals may be inclined to reduce the size of their accommodation, they often prefer to stay in the same location, potentially leading to higher-than-anticipated repurchasing costs.
- Investing now and selling later. For instance, if you are more than 10 years away from retirement, you might contemplate borrowing to invest in a property, for example. The idea is to later sell that asset around 20 years from now, repay the debt, and utilise the equity to repay your home loan.
- Draw from super. Your strategy might involve making tax-efficient additional contributions into your superannuation so that you can invest this capital in a low-tax environment. The goal is to continue this approach until retirement, allowing you to withdraw these funds tax-free and subsequently repay your home loan.
Depending on your situation, there are several alternative strategies for repaying your home loan (Plan B) that you might consider implementing.
(4) If you are self-employed, speak to your accountant
If you’re self-employed, it’s advisable to consult with your holistic accountant to explore potential ways to structure your business and tax payments that improve your cash flow and allow you to repay your home loan faster. While the feasibility of this approach depends on your specific circumstances, we have successfully assisted many business owners in repaying non-tax-deductible debt at a greatly accelerated rate. This is yet another example of your accountant having the scope (licenses and team resources) to provide holistic advice.
All other ideas tend to be unimportant or inferior
While some articles may present 10+ ways to repay your home loan faster, the effectiveness of many of these ideas is often limited, yielding only marginal savings. In reality, more than 95% of the success lies in minimising the cost of debt, leveraging an offset, and channeling as much cash flow into your home loan as soon as possible. It is not more complicated than that.