Paying Down Your Home Loan

When it comes to paying down your home loan it is amazing how much benefit you gain from the smallest extra repayment.  There are many different ways to do this and in this article we will list a few and you can decided whether any one of them suits you.

Before we get into methods of reducing repayments we should take a look at the average 30 year home loan, or mortgage loan as it is sometimes called.  If you borrow $300,000 over 30 years at an average interest rate of 8.5% (Don’t forget that rates go up and down but usually average between 8% and 9% over 25 years.)  Your total repayment will be around $858,000.  The first $300K is the amount you borrowed and the balance of $558K is what you pay in interest and various fees and charges over the 30 year period of the loan.

Naturally there is nothing that can be done to reduce the amount you borrowed, $300,000, because that is your debt and must be repaid.  What we can do to save money is attack the amount of interest that you pay.

One of the most popular and successful methods of reducing interest is by having a drawdown account attached to your mortgage so that you pay your entire income into the mortgage account and your interest calculation is made each month on what you owe minus the amount of cash in your account.  For instance you net monthly income is $6,000, mortgage repayments are $2,500 and living expenses are $2,000 this leaves an amount of $1,500 in the mortgage account each month that will reduce your interest liability.  Now be warned, this type of account is useless if you do not have at least 10% of net earning left over after loan repayments and living expenses.  Before you agree to this type of loan be sure that you have at least 10% excess cash each month.

Another popular system is to budget so that you pay half your monthly repayments every fortnight (2 weeks).  There are only 12 months in each year but there are 26 fortnights which means that you repay 13 months each year rather than 12.  It doesn’t seem like much but never forget that the extra month’s payment comes off the capital that you borrowed, not the interest which means at the end of year 1 you pay down and extra $2,000 (approx).  Now your debt is no longer $300K but $298K, and this is where it gets real good; you continue making repayments at the original amount so that with each payment you make a little more comes off the principle (amount borrowed) until at the end of the second year your debt is proportionally lower.  They can only charge interest on the amount outstanding so all extra payment come off the capital.

The final method is the one I used on my first home and was amazed that after just 5 years living in the house my 25 year mortgage had shrunk to just another 7 years if I kept paying the same amount.  The method is simple; during the interest rate upward cycles each time the rate increased I had to pay more, when the rates started to move down again I kept my payment at the same rate as when it was high.  Obviously I had made changes to my budget to meet the increased amounts so there was little pain in keeping the payments at those levels.

There are many other methods of paying down the home loan but the three above are the most popular and will hopefully give you some ideas.  Never forget that if the bank is charging you 8% interest on your home loan and offering you 4.95% for savings by putting you savings into your home loan you are getting 8% on your savings.  The 8% is delivered by the fact it is 8% you are not having to pay out and that is superior to 4.95% on savings which leaves you with an extra 2.05% to find to make the payments.