One simple strategy could shave years off the life of a home loan, saving hundreds of thousands of dollars in interest along the way.
The Reserve Bank of Australia held interest rates steady for the fourth month in a row in October, but households are still seeing their mortgage repayments rise as the previous hikes continue to flow through and borrowers reach the end of their fixed term.
But there’s one easy thing borrowers can do now – for free – that will save them a fortune over the long run, and it’s likely your lender won’t let you know about it.
Speaking to realestate.com.au, Mortgage Choice broker Paul Williams said borrowers who pay off their loan fortnightly instead of monthly could cut around five and a half years off the life of their loan.
“Because in effect, you get a whole extra months’ payment per year. So rather than 12 monthly payments it’s 26 fortnightly payments,” Mr Williams said.
“The default for all banks is automatic monthly repayments. Some banks make it a little confusing for people because that is all they offer.
“But what people need to understand is that so long as they meet the minimum contractual monthly mortgage payment, that is all the bank wants to see.
“You can still meet your minimum monthly repayment by paying fortnightly via a simple direct debit.”
Not only will borrowers cut years off their loan term, but the interest savings can add up to hundreds of thousands of dollars, he said.
Since lenders calculate interest daily based on the outstanding balance of a loan, over time the savings add up.
“If you pay fortnightly your balance is lower for longer, so as a consequence the interest calculation is lower,” he said.
“Paying down the mortgage quicker by paying fortnightly is a significant saving in interest, and it’s even greater than it was 12 months ago because rates are now higher.”
How much a borrower could save
An example scenario from Mortgage Choice revealed a borrower with a $500,000 mortgage could save almost $122,000 in interest over the life of their loan, and cut down their 30-year loan term by 5 years and 5 months, if they made half their monthly mortgage payment every two weeks instead of once a month.
For a borrower with a $1 million mortgage, the interest savings jumps to almost $244,000.
In these calculations, the borrower is assumed to be on a variable interest rate of 5.95%, paying principal and interest, with a 30-year loan term.
With most standard bank loan contracts normally set at monthly repayments, Mr Williams said many miss out on the savings.
“Banks don’t necessarily point out to people that there’s a benefit in paying fortnightly,” he said.
“As brokers we always recommend paying fortnightly, and those who do enjoy significant savings.
Paying fortnightly instead of monthly can wipe years off your home loan. Picture: Getty
“Most employees are paid fortnightly anyway so it’s really easy to do at the start or even during the term of the loan.
“If somebody is paid by their employer monthly, they can still set up a fortnightly repayment for their mortgage and enjoy the same savings.”
In addition to adjusting repayment cycle frequencies, Mr Williams said borrowers who make additional repayments on top of the minimum amount will benefit over the long term.
“For example, if people get an annual bonus, or they get their tax refund, or if they can afford to pay even an extra $50 a month, it can amount to thousands of dollars in savings,” he said.
“And most variable rate mortgages also have a redraw facility, so people can still retain access to those funds if they need to redraw any additional repayments.”
Even small additional contributions can add up to big savings over the life of a home loan. Picture: Getty
He said borrowers may also be paying for features they don’t need, such as an offset account.
“Is it necessary to have an offset account?” Mr Williams said. “Can I switch my current mortgage to a basic variable rate with a redraw facility to save some money in interest and indeed annual fees?
“There are several ways brokers can help people to save money in a [higher] rate environment.”
While borrowers on a fixed rate home loan are more limited with additional repayments, Mr Williams said there are still opportunities to get ahead.
“Most lenders only allow up to $10,000 per annum [in additional repayments] for a fixed rate loan,” he said. “And only two lenders that we are aware of have offset accounts against fixed rate loans.
“So it’s important that people talk to their broker or their bank and understand how they can maximise their repayments or minimise interest, whether it is a fixed rate loan or a variable.
“The common misconception is that there is no flexibility for a fixed rate loan. The reality is there is some flexibility as opposed to no flexibility.”
Borrowers reaching the end of their fixed term should get on the front foot early to avoid rolling onto their lender’s standard variable rate, he added.
5 simple things you can do to save on your mortgage:
- Increase repayment frequency and make payments fortnightly instead of monthly
- Make extra repayments, whether regularly or ad-hoc
- Use a redraw facility or offset account
- Renegotiate current mortgage rate
- Shop around for a more competitive interest rate