It takes foresight to look 10 or 20 years into the future and consider what your finances will look like. It takes discipline to enact a plan to improve the outcome. If you are quite comfortable living day to day or week to week, it’s easy to overlook the power of making minor savings over the long term.
But you will definitely thank your younger self down the track if you can find a way to put a little extra on your mortgage regularly. Making additional repayments makes a massive difference over 20 or 30 years, significantly reducing the interest you pay and taking years off your home loan. You will typically need to be on a variable interest rate to be able to make additional repayments regularly.
Let’s say you have a home loan of $300,000 with an interest rate of 4.5%. If you make additional repayments of $200 per month, you would save almost $60,000 in interest and reduce your loan term by over six years.*
Many people can make extra repayments at certain times but are worried they may want access to these funds in case of a change in circumstances, or in case they want to make another large purchase. There are two main options to accommodate this; both are common home loan features – a 100% offset account, or a redraw facility.
Here is an overview of these two options.
100% offset account:
An offset account is a separate savings account that is linked to your home loan.
The amount held in your offset account is subtracted from your loan balance each day, reducing the interest charged. For example, if you have a home loan of $300,000, but you have $20,000 in your offset account, your interest is calculated on $280,000.
It has a normal transaction account functionality so you can withdraw funds easily as often as you like without needing further permission.
For investors, this may be a more effective option for accounting and taxation purposes.
This feature allows you to withdraw any additional repayments you have made on your mortgage through the home loan account itself.
Until the funds are redrawn, however, they go onto your home loan, thereby reducing the interest charged. For example, if you have made additional repayments of $20,000 on your $300,000 home loan, interest will only be charged on $280,000.
While the money is available, it usually isn’t readily accessible, and you will need to apply through your lender. This helps with ‘forced savings’.
You can see your home loan balance reducing, which can be a mental boost.
Fees may apply to redraw funds (depending on your loan).
Remember, of course, if you take the money out, it needs to go back in at some point to maximise the savings. The quicker you can put those funds back on your mortgage, the quicker you’ll be back on the road towards reducing your home loan.
So take a look at your budget. If you can find $50 a week (less than the cost of buying lunch every day) or even more, consider putting it on your mortgage. In 20 years’ time, you’ll be happy you did.
Effects of paying an additional $200 per month:
Calculated on a $300,000 mortgage with a 30-year loan term and an interest rate of 4.5%. Other costs may apply.