12th March 2009
Paying off the mortgage is attractive
For most people, having a mortgage will be the biggest financial commitment they will take out in their life. So, after another round of rate cuts by the RBA, not only is your mortgage costing you less, but this is a great opportunity to make a real dent in that loan.
In a recent Financial Review article, the many benefits were highlighted, and there is real reason for excitement about taking advantage of the lower rates. The article uses this example. If your tax rate is above 31.5 per cent, putting extra funds into a home loan is tax effective, too. For example, a couple who are both paying 31.5 per cent tax (with each earning more than $34,000.00 a year), the return they would need from another investment to better the after-tax saving from repaying their 5.5 per cent mortgage would be at least 8.02 per cent, risk free.
Yes this is over the life of the loan, but you have to ask yourself where else could you get a similar or better level of return risk free?
This would apply to investments made with after-tax money - the same as cash used to pay the mortgage. Salary sacrificing pretax money into super would obviously show a different result.
If there's a strong case for paying off the mortgage for those paying 31.5 per cent tax, it's compelling for those paying 41.5 per cent and more in tax.
Using the same 5.5 per cent home loan rate, the return someone on $80,000 paying 41.5 per cent tax would have to get from another investment to improve the after-tax savings of extra home loan repayments would be just above 9.4 per cent, again risk free.
Paying extra dollars off your home loan is like getting an extra tax-free return.
Redraw facilities - which let you withdraw any extra repayment you've made - can be used if the funds are needed at a later stage.
At La Trobe there are no fees or penalties for accessing your redraw and it is available on 24 hours notice.
For households that can afford it, it's really worth capitalising on the interest rate cut by taking it further - either continue making monthly repayments at the old rate or make even bigger repayments. When interest rates go down and you continue making higher repayments, a bigger chunk of your cash goes on the principal of the loan, which means you pay it off more quickly.
Take a $200,000 home loan, where the standard variable rate was 7.69 per cent and is now the full 1 percentage point lower at 6.69 per cent. The monthly repayment will now be $1374.25. You can choose to take the lower repayment and your loan will take 25 years to pay down. But if you continue paying at your old rate ($128.54 more a month), you will pay off your loan four years and eight months more quickly and save $45,964.83 in interest costs over the life of the loan.
Now that is an attractive proposition!
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Head of Lending
Iain Pepper is a Vice-President and the Head of Lending for the La Trobe Group.Read full profile here.
La Trobe is one of Australia's leading independent specialist mortgage Financiers. Its business includes residential mortgages, commercial mortgages, and investment services operating one of Australia's largest Mortgage Funds under AFSL 222213. It employs over 145 staff and has raised over AUD$10Billion to assist over 100,000 customers since inception in 1952.
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