June 13, 2012
The method you use to repay your home loan can make a big difference to the time it takes to repay your loan, and how much interest you pay over the life of the loan.
Let’s take a look at principal and interest home loans, or a ‘P&I’ loan. This type of loan is particularly popular among owner-occupier borrowers. The home loan ‘principal’ refers to the total funds that a lender agrees to loan to you. It is the loan amount before interest is added. A loan’s interest refers to the percentage of the principal that you pay to use the lenders’ money. In most cases interest on your loan’s principal balance is calculated daily and charged monthly.
At the start of a principal and interest loan, it can take a while before you start to see the principal amount reduce as most of the funds go towards paying interest. The good news is that there are repayment methods you can use to pay down your principal loan amount quicker.
One approach is to make loan repayments above and beyond your monthly or fortnightly minimum repayments. Many of today’s home loans allow borrowers to make additional repayments without incurring fees or penalties. By making smaller, frequent additional repayments you can make a noticeable difference to your loan term and the interest you have to pay. If, for example, you borrow $300,000 over 30 years, repaying the loan at an interest rate of 7%, with monthly repayments at $1996. By upping your repayments from day one by $200 a month ($50 per week) to $2196, you could save $116,641 in loan interest and knock 7 years and 2 months off the loan term.
Not confident in your ability to make additional repayments? It can be helpful to go back to basics and prepare a detailed household budget – that is, if you haven’t already. Reviewing your everyday expenses budget may help you uncover many clever ways to put aside extra dollars to put into your mortgage. There are budget resources that don’t cost a cent that can be used online or downloaded. The government’s MoneySmart website, Moneysmart.gov.au/tools-and-resources/calculators-and-tools/budget-planner is a popular resource. There are also plenty of budgeting apps for smartphones that are available for as little as a couple of dollars, such as Jumsoft Money, Pennies, Left to Spend and Reconcile.
Another way to reduce the principal is to borrow the money over a shorter loan term. Everyone’s financial situation is unique so this option will only suit those who have the financial capacity to make higher repayments throughout the loan term. For instance, take a $300,000 loan at 7% over 25 years instead of 30. Repayments are $124 per month higher, but the difference in loan interest adds up to more than $82,420. Should you decide to reduce your loan term after you’ve been paying it off for some years, your lender may charge you a fee for doing so. Check with your mortgage broker.
When choosing a home loan, there are many factors to consider, such as the home loan’s interest rate, fees and charges and whether to opt for principal and interest vs. interest only repayments. Borrowers also have the option of a fixed or variable interest rate loan, or a combination of the two.
Choosing a home loan on interest rate alone isn’t a highly recommended approach, as a home loan’s features, benefits and fees can sometimes have a bigger impact over your home loan than interest rate alone. It’s always a good idea to talk to an expert about your personal and financial circumstances, as today’s loans can be tailored for your own financial goals.
For more information contact Richard Windeyer on 1800 01 LOAN or click here to "Book a Meeting"