25 November 2013
... That's Lending
10 Borrower tips to save money
There are always steps borrowers can take to pay their loan off faster. Here are a few ideas that will help them along the way.
- Skip the honeymoon rate
There are two problems with honeymoon rates. First, the variable rate is often higher than some of the lower basic loans
available so you could end up paying more. Second, you need to clearly understand that a honeymoon rate applies only for
the first year or two of the loan and is a minor consideration compared to the actual variable rate that will determine
your repayments over the next 20 or so years.
- Make repayments at a higher rate
A good way to get ahead of mortgage commitments is to pay it off as if you have a higher rate of interest. Get a
loan at the lowest interest rate you can and add 2 or 3 percentage points to your repayment amount. So if you have a loan at about
6.99 percent and pay it off at 10 per cent, you won't even notice if rates go up. Best of all, you'll be paying off your
loan quicker and saving yourself a packet.
Every dollar you put into your mortgage above your repayment amount attacks the capital, which means down the track
you'll be paying interest on a smaller amount. Extra lump sums or regular additional repayments will help you cut many
years off the term of your loan.
- Pay it off quickly
Time is money. There are all sorts of strategies for paying less interest on your loan, but most of them boil down to one
thing: Pay your loan off as fast as you can. For example, if take out a loan of $300,000 at 6.99 per cent for 25 years,
your monthly repayment will be about be about $2,134. This equates to a total repayment of $640,126 over the term of your loan.
If you pay the loan out over 10 years rather than 25, your monthly payment will be $3,494 a month (ouch!). But the total
amount you will repay over the term of the loan will be only $419,290 - saving you a whopping $220,836!
With most new loans, the first instalment may not become due for a month after settlement. If you can manage it (and your
lender will let you), pay the first instalment on the settlement date. If you do this, you will be one step ahead of the
lender for the term of your loan. Every little bit counts.
- Make more frequent payments
One of the simplest and best strategies for reducing the term and cost of
your loan (and thus your exposure should interest rates rise) is to make your repayment on a fortnightly rather than
monthly basis. How can this make a difference I hear you ask? It works like this:
Split your monthly payment in two and pay every fortnight. You'll hardly feel the difference in terms of your disposable
income, but it could make thousands of dollars and years difference over the term of your loan. The reason for this is
that there are 26 fortnights in a year, but only 12 months. Paying fortnightly means that you will be effectively making
13 monthly payments every year. And this can make a big difference.
Using our example from above, by paying monthly, you will need to repay $640,126 over the term of your loan. By paying
fortnightly, you will save $48,534 in interest and 4.5 years off the loan. Zero pain to you, major benefit to your
- Get a package
Speak to your lender about the financial packages they have on offer. Common inclusions are discounted home insurance,
fee-free credit cards, a free consultation with a financial adviser or even a fee-free transaction account. While these
things may seem small beer compared to what you are paying on your home loan, every little bit counts and so you can use
the little savings on other financial services to turn them into big savings on your home loan.
- Consolidate your debts
One of the best ways of ensuring you continue to pay off your loan quickly is to protect yourself against interest rate
rises. If your home loan rate starts to rise, you can be absolutely positive about one thing - your personal loan rate
will rise and so will your credit card rate and any hire purchase rate you may happen to have.
This is not a good thing as the interest rates on your credit cards and personal loans are much higher than the interest
rate on your home loan. Many lenders will allow you to consolidate - re-finance - all of your debt under the umbrella of
your home loan. This means that instead of paying 15 to 20 per cent on your credit card or personal loan, you can
transfer these debts to your home loan and pay it off at 6.99 per cent.
As always, any extra repayments or lump sums will benefit you in the long run.
- Split your loan
Many borrowers worry about interest rates and whether they will go up but don't want to be tied down by a fixed rate loan. A
good compromise is a split loan, or combination loan as they are often known, which allows you to take part of your loan
as fixed rate and part as variable rate. Essentially this allows you to hedge your bets as to whether interest rates are going to
rise and by how much.
If interest rates rise you will have the security of knowing part of your loan is safely fixed and won't move. However,
if interest rates don't go up (or if they rise only slightly or slowly) then you can use the flexibility of the variable
portion of your loan and pay that part off more quickly.
- Forgo those minor luxuries
This is the bit you don't want to read. Once you have a mortgage, your life is likely to be luxury-free (or at least
pretty close to it). Think of all the weight you will lose by giving up your favorite indulgent snack. For the sake of
your health you should quit smoking and drink less anyway. Take your lunch from home and save on bad fast food. Trust us,
your body will thank you for it.
If you're still not convinced consider the following example. A typical day may include a pack of smokes ($10), a coffee
and donut ($5), lunch ($12) and a couple of beers after work ($8). That's $35 a day or $175 a week or $750 a month or
$9,100 a year.
Assuming a mortgage of $300,000 at 6.99 per cent over 25 years, by making $750 in extra repayments each month, you'd save
more than $175,000 in interest and be mortgage free 11 and a half years sooner.
No one is saying you should live a convict existence but just cutting down a little on your expenses will see you reap
huge financial benefits.
- Run an offset account
Instead of earning interest, any money you have in your offset account works to offset the interest you are paying on
your home loan. For example you may have a mortgage of $300,000 at 6.99 percent and an offset account with $50,000 in it
earning 3 percent.
This means that $250,000 of your loan is accruing interest at 6.99 percent but the rest is accruing interest at almost 3 percent
(6.99 percent on your loan less the 3 percent the $50,000 in your offset account is earning). Imagine how
much you can save!
Of course, the best sort of offset account pays the same rate as your loan (100 per cent offset).
- Pay all your mortgage fees and charges up front & avoid risk fees
Some lenders allow you to add to the amount you borrow instead of coming up with cash for your upfront costs. While this
can seem a blessing try to avoid doing this. Consider the following example:
Borrower A borrows $300,000 over 25 years at 6.99 percent. Her upfront costs are $1,000 but she has enough cash to make
sure she can cover these. Her total repayment over 25 years will be $640,126.
Borrower B takes out the same loan but doesn't have enough cash to cover the upfront costs. So he borrows $301,000, at
the same rate. His total repayment over 25 years will be $642,215.
Two thousand odd-dollars might not sound like a huge amount but what could you buy with it if it stayed in your
Paul Wells, Chief Investment Officer
La Trobe Financial Asset Origination & Credit Division
La Trobe Financial is one of Australia's leading independent credit specialist Fund Managers. Its business includes residential mortgages, commercial mortgages, and investment services operating one of Australia's largest Mortgage Funds under AFSL 222213. It employs over 123 staff and has managed over AUD$10Billion covering over 100,000 investment grade assets since inception in 1952.
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