I've heard from a few people that most home loans could be paid off well before the term of the loan. I want to understand what are the strategies fellow ozbargainers have adopted to smartly pay off their home loans. Thanks in advance for sharing
Paying off Home Loan Faster
Xplosive on 25/11/2016 - 12:00
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what does paying it fortnightly/weekly achieve ?
Instead of pay Monthly which is 12 Months in year, if pays 52 weeks or 26 fortnightly will cover 13 months of re-payments
Only relevant if you don't have an offset. Otherwise I don't see the benefit
@ozyboy: Surprised why people don't ask the bank how the interest is calculated, what is a offset mortgage, and rounding method they use? The number of times I've heard of friends and family members paying a mortgage broker, or a financial planner to tell them exact same thing is scary!
52 and 26 still makes up a year
you're assuming the average person/family will be disciplined not to spend the extra repayment and leave it sitting in the offset over a long-term period (5,10,15 years). Given the question/topic is "paying home loan off faster", it's just easier to make the additional repayment.
Haven't had much experience with home loans but the fine print on personal loans is now calculated daily based in annual interest rate divide by 365. I'm assuming that some home loans have shifted to this.
So by paying it weekly as opposed to monthly, you're slowly reducing the daily interest amount a little faster than monthly. Even though it's a small amount, it adds up at the end of the loan.
@DangerNoodle: Many loans calculates interest per day, but they calculate it monthly in advance unless when you have saving account when the interest is calculated at the end of month.
You can see that in your statement.All the offers i've seen with offset have a higher rate than no offset. If you are going to put most of your disposable income into repaying, consider non-offset with a lower rate.
@cashews: the fact is 1 week = 7 days so 4 weeks = 28 days (can only be a month on Feb) =/= 30 or 31 days as a normal/full month = > yes, paying weekly means you actually pay averagely extra 2 days per month => 1 extra month of repayment.
Interest is calculated daily - so if you pay fortnightly instead of monthly, the Principal amount is slightly smaller for the second half of the month (by the amount you've paid at the fortnightly interval).
If you are depositing fortnightly in first and third week of a month, you are paying interest more compared to monthly instalment paid in first week of the month.
That would depend on how you've started paying off your loan and whether you actually have the funds to make a whole month's payment at the start of the month - not everyone has that cash flow.
@bobbified: It depends on how the loan was setup.
But doesn't that mean the comment you made above depends on when you are paying your installments monthly or fortnightly and not on if you pay instalments monthly or fortnighly?Payments are not necessarily on the first or last day of the month.
In my comment above, I've used a whole "month" to highlight a cycle that most people are familiar with to illustrate the concept of monthly vs fortnightly.
The logic is, the sooner you put money into the loan to offset the daily interest calcs, the less interest there will be overall.
@bobbified: I agree with your comment above, but not with the statement you made earlier:
if you pay fortnightly instead of monthly, the Principal amount is slightly smaller for the second half of the month (by the amount you've paid at the fortnightly interval)
Which might not be true and depends on when is your instalment taken. If my monthly instalment goes in first or second week of the month, it will be better compared to fortnightly.
If my monthly instalment goes in first or second week of the month, it will be better compared to fortnightly.
Do you even realise you're arguing something different? If you have the whole monthly payment at the start of the month, then of course it's better to dump the whole amount in minimise interest.
Even better - if you put your entire annual payment into the loan in the first week of the month, you'll save even more interest. The problem is, not everyone has that whole amount in one go.
Having worked in a bank in lending and seeing this I was always impressed at how big of a difference paying fortnightly had over paying monthly however the difference from fortnightly to weekly was not nearly as large.
I don't know which dunce negged you, but that is right on the money (no pun intended)…fortnightly is indeed the sweet spot.
Pretty simple really.
26 Fortnights in a year, only 12 months. Paying fortnightly means an extra 2 payments.
52 weeks in a year compared to 26 fornights the only benefit is the interest which works out to be virtually nothing.
Weekly is actually the sweet spot / optimal repayment frequency.
The benefit is not as great as the change from monthly to fortnightly, but it is still slightly more advantageous to make weekly repayments as opposed to fortnightly.
@born2reign: No it is not. The benefit of weekly vs fortnightly is actually so small that it's functionally negligible…there's a ton of online calculators out there to help you understand this.
@born2reign:
Depends on your pay cycle. If you get paid fortnightly, no point paying weekly. Just pay what you would have paid the day you get your pay.Agreed it's a small benefit, last time I checked it saved $50 annually but it is still more beneficial than paying fortnightly nonetheless :)
If the goal is to pay down home loan faster as the OP has stated, then it's worth doing, in conjunction with storing all other available cash in 100% offset account and living off 55 day interest-free credit card etc
Question….
1) put all my savings+salary into offset and pay mortgage monthly
2) put all my savings+salary into offset and pay mortgage more often (weekly/fortnightly)There is no difference in saving interest rates in the 2 scenarios because interest is calculated daily. As long as I maintain and continue to dump my salary into offset, it's the same (interest is being minimised). Is this correct?
@StewBalls:
It depends on how often you get paid. I get paid monthly so I make a mortgage payment on that day. It wouldn't help to hold half back for two weeks.Yes in theory, the interest rate and interest being calculated daily is not relevant here but the key point here is whatever money that is in your 100% offset account is the same as having put into the actual loan itself (i.e. for interest-calculations purposes both methods lower the interest payable by the same figure).
The main factor to consider here is how financially disciplined you are, if you're able to have the offset accumulate into tens of thousands of dollars and not impulse buy or spend it on unbudgeted items (luxury items/holidays/cars etc), then by all means pay interest-only on your loans and build up the offset account until it becomes in the tens or hundreds of thousands (remember for interest purposes, it's the same thing as paying all of this into the loan itself).
BUT if you're not super disciplined financially, and your offset account bounces around like a yoyo due to casual spending, impulse purchases for you (or a partner), then you are better off paying it into the loan frequently so that you "cannot see or touch the money, as it is gone"
paying more frequently either via offset or regular repayments effects the interest calculation.
Banks calculate interest at the end of every day (including weekends and public holidays and then charge the interest at the end of the month or whenever your billing cycle is.
i.e. If you pay more, the interest calculated on that day would be less and you will be charged less meaning more of the money you pay will go towards repayment principal (the money you actually borrowed instead of just interest to the Bank)
All this only if there is no offset otherwise makes no difference.
To my understanding, Banks calculate interest at the end of every day for saving accounts.
For loan accounts, it is calculated every month even if it is calculated for each day. So if you are paying weekly or fortnightly or monthly, your interest will be same. Check your loan account statement.So as few members suggested, there is small benefit of paying fortnightly or weekly.
Good way to put the extra savings in offset or Redraw account.
Interest on loans is definitely calculated daily and charged monthly.
I have reconciled my on loan account and confirmed with a source who works in a Bank.If you don't believe me, put $100 into your loan account for a couple of days and then calculate your interest, the interest charged will be less by the ~1c for every day you had it in either an offset or in the loan account itself. (this assume your interest rate is about 4%)
Also save money by using sites like ozbargain and put saved amount
into buying more stuffinto the offset account.
I used a 'line of credit' loan rather than home loan as it was more flexible in paying every spare cent into it and micromanaging advance payments. It was still secured by land title, but I had control over when and how much was repaid. Home loans are more rigid with fixed repayment terms and auto direct debits etc.
I'm not sure how much you are aware of, but make sure you look at the large exit fees on fixed rate mortgages. They gouge you on every lost cent the banks lose. If you want to exit early, variable rate is much cheaper.
How do they compare with home loans in terms of interest rate etc?
For me it was the same. It started out as a home loan against title and shortly after I said I wanted to pay money off exactly when I get it and not direct debited afterwards and they changed it to line of credit. You can also redraw whatever amount you need (within the loan amount - repayments) so in the worst case, you could get all your advance payments back instantly.
What's a catch then? Why isn't it as popular as home loans? Just trying to understand.
@virhlpool:
The average customer pays off their home loan slowly and the banks make more money off people paying off their home loan slowly. It only came up when I asked the bank not to bill me mortgage repayments when I was paying 3 times more early repayments that month. It worked well using netbank to micromanage everything and early repayment exit fees were only a few hundred bucks.Generally interest rates are higher. First time I'm actually hearing it is the same interest rate. Flexibility costs money (usually)
@Shadowsfury:
I think for paying off early, the huge exit fees for a fixed rate mortgage would be easily highest of all. Maybe on some of these crazy modern 500k+ mortgages the interest rate works out much bigger than my case where exit fees were a large factor and I was looking to pay off in 2-3 years. 27 fixed rate penalty years was scary.@Shadowsfury: In the past they may have been the same, definitely not now since the tigher lending rules have been recommended to banks - any sort of investment loan has higher interest rates.
Banks also do not advertise these anymore, people were taking out line of credit mortgages and using them to fund property construction (a construction loan has a much higher risk - and interest rate)
LOC's compare worse by about a percent (to say a typical no fee base variable), though depends how hard you can negotiate and how much your borrowing.
I'm on this too and enjoying the flexibility. You can withdraw from your line of credit for any purpose.
The only catch is when interest rates rise (it's variable rate only).
Work more/harder
Yeah I really don't think there are any particular ways to pay off your house faster, other than "Save more" and "Pay less" (i.e lower rate). And even then, you are somewhat constrained by your ability to earn more money, and there's only so much money you can not spend per month - you've got fixed expenses, and then you also want to have a decent life
or smarter
spend less money, only buy bargains that you actually need. leave the rest for others on here to scoop up
Logged in to say this. Cutting spending and developing willpower is vital.
offset account.
live off credit card and pay closing balance off completely every month. do not miss any payments.Pay off credit card balance by direct debiting offset account, no more missed payments.
Until some joker scams your credit card. The bank cancels your card (1 of 4 on the account) and the fraudulent purchases. But neglects to mention the automatic full payment for the whole account stops working! Luckily they refunded the $2.4k - 3 months of interest.
Said it would be on me if it happened again.
You can generally pay back a loan as soon as you have the money. There's generally no obligation to stick to the payment plan, and the 25/30 years is the maximum amount of time you have to pay it back. It's like lending a mate $120 and he says he'll pay you back $10/month for a year. It doesn't matter if he pays you back all $120 after month 2.
Offset accounts, and getting your wage paid directly into your onset account.
If you have a $400,000 loan, and have it at 4% per annum, you're paying $16,000 per year (or $43/day) in interest.
Depending on your situation, consolidating all your finances to go into the offset account (any amount outside of your offset account is costing you interest). Do you have shares or other investments? It may be worth speaking to your financial adviser about the benefits of selling them and putting the money into your offset account.
Putting purchases on a credit card with no annual fee and an interest free period. By delaying the payment you are saving interest.
And obviously, spending less money so you can pay it off quicker is the easiest way, and there are countless threads on here about how people save money.
It's like lending a mate $120 and he says he'll pay you back $10/month for a year. It doesn't matter if he pays you back all $120 after month 2.
It's actually different because your mate doesn't charge you interest so it's better for him to get the money back as quickly as possible.
The banks prefer you to take longer to pay (as long as the regular payments are actually made) so that they can earn interest on the outstanding amount. They used to have an early repayment fee (penalty) for that reason. (Nowadays that fee isn't so common).
4% is terrible. You need to talk to you bank manager ASAP and get that down to at least 3.8%, if you're on a fixed interest loan it should be way cheaper again. Unless you are above the 80% LVR, then I take this all back :)
While you're at it get them to waive the annual fee… for life!
And throw in a top of the line reward earner credit card of your choice for free.
Got to upvote you on this, because 4% is terrible!
I just used it for simple round numbers :)
Which one of the Big 4 are offering 3.8% and on what amount?
I know NAB will, they all would play ball if you have a descent size loan and and want your business. I can't get much lower then 4% myself as I'm down into double figures. :(
@Risser: i have a hefty loan and I did ask NAB for their best price and they didn't get anywhere near 3.8%. Either as part of their package or a stand alone loan .
For the record, 3.8% interest rate is a 1.45% discount off their advertised variable rate of 5.25% for owner occupied, principal and interest loans.
I also shopped CBA, ANZ and WBC. None of them could/were willing to go that low for a loan over $1 mil. Not on a variable rate anyway.I would be eternally grateful if you could forward me the details of your nab contact or any other big 4 contact that could help me get 3.8% or below as you mentioned in your post.
Thanks in advance
most home loans could be paid off well before the term of the loan.
That's right. you will only pay off the loan for the whole 30 years if you make minimum repayment every month. If your loan has an offset account or a redraw facility, simply putting the extra money into offset or pay the extra portion into the loan will reduce the loan life significantly.
I hope nobody has the minimum mortgage repayment equal to their monthly income.
My wife and I knocked 7 years off our 30 years loan in 2 years. CBA and many banks give you the updated loan life based on extra money you pay :)
I halve paid 1 third of my home loan off. So I use the equity in my home to:
1) Buy shares with an interest only investment loan.
2) Dividends earned from these shares go back in to my home loan offset account (paying home loan off faster).
3) Interest paid on these shares loan is tax deductible. As well as franking credits. The inevitable tax refund goes back into my home loan offset account. (paying home loan off faster)
4) As I pay off more of my home loan, I am able to borrow more for the share investment loan. Expanding the share portfolio, increasing the dividends and interest payable tax deduction (Snowball effect of wealth generation for paying my home loan off faster)
5) The share portfolio should grow over the lifetime of the loan. This doesn't directly help pay off my loan faster but is a bonus if I manage my portfolio well I have a nice profit at the end if I choose to sell the entire portfolio.Basically its a 4 pronged strategy to pay off my home faster. Each element is important. I need to be doing all four to maximise the value and speed of paying off my house.It's a basic Wealth generation, tax reducing strategy, and probably one of the first any financial adviser will recommend to you to start out with if you want to start small and generate wealth (by paying off your house faster) over time.
Her4e's some example figures to highlight how it's supposed to work… roughly speaking and the snowball effect. Notice how my total debt remains at the same level but shift my debt into shares over time out of my home which increases the advtange on your:
Year 0:
Home Loan: 500,000
Share Loan: 50,000
Total: Debt: 550,000Dividends yearly: ~3000 (pump back into home loan)
Share Loan Interest (Tax Deduction) yearly: ~2000 (pump tax refund back into home loan)Year 5:
Home Loan: 450,000
Share Loan: 100,000
Total: Debt: 550,000Dividends yearly: 6000 (pump back into home loan)
Share Loan Interest (Tax Deduction) yearly: 4000 (pump tax refund back into home loan)Year 10:
Home Loan: 300,000
Share Loan: 250,000
Total: Debt: 550,000Dividends yearly: 15000 (pump back into home loan)
Share Loan Interest (Tax Deduction) yearly: 10000 (pump tax refund back into home loan)Year 15:
Home Loan: 100,000
Share Loan: 450,000
Total: Debt: 550,000Dividends yearly: 27000 (pump back into home loan)
Share Loan Interest (Tax Deduction) yearly: 18000 (pump tax refund back into home loan)The caveat to all of this working is a well managed share portfolio (perferably with professional advice).
Note: The maths here is very rough and probably doesnt actually add up if you get your calculator out as I didn't actually work it out year by year. Highlighting the strategy only.
The other option/flavour of this is to go for the investment property instead of shares, but it's a bit less flexible to generate the snowball effect year on year as you can with a share portfolio. Property is a bit more of a slow and steady burn to generate wealth. Shares have more flexibility and growth but higher risk. Property also has a bit more of a "big bang" hit to your finances infrequently where as shares you can increase small amounts every 6-12 months if you like.
*** This is not financial advice yadayadayada
Only works if dividend yield is consistently higher than the home loan rate. Your example seems to have a 10% dividend yield. Not easy to find such shares these days.
Note that shares are risky investments, so if you can't sleep because of market fluctuations, it might not be worth it.
Also for the loan interest (allocated to shares) to be tax-deductible, there are strict requirements by the ATO. The purpose of the loan determines the tax deductibility of the interest, so if you borrowed the money for an owner-occupied home, using that money to buy shares might not qualify it as deductible.
The dividend yield doesn't need to be much higher but the higher the better. Once you factor in the yield and tax deduction, you still come out ahead than if you did nothing and simply had an offset account.
Nah my example is at 6% yield which is easily achievable. 50000 x 6% = 3000 per annum.
And yes a separate loan account is advisable so the investment funds can be easily accounted for as investment purposes.
But to bad if the market has one bad year. If you have another GFC event (even one that is half as bad) then you lose your divs and capital gains and have the added bonus on being called on your margin loan and having to pay out a bunch of CGT cause you had to dump your shares!
Wrong
1) It's not a margin loan. It's an identical loan to an investment property. There are no margin calls.
2) you don't dump your shares in market dips
3) you ride the gfc bumps and dips which are inevitable and will happen again as companies continue to pay dividends even during share price slumps..
So you have a down year, and you are stuck paying off two loans instead of one, little or no dividends, you can only get so much of a tax break.
Dividends are not paid doing major slumps. Or were you telling yourself that they do when the banks stop paying divs during the GFC? After all, they NEVER don't pay a dividend? (or so everyone said at the time). You realize that some companies slum in share price, then crash, then go out of business?
Lets face it, you do this strategy at the start of the next downturn and it could take years just to recover your portfolio value let alone the dividend yield and the interest costs. Plus if you don't have the excess cash flow to "ride it out" well you do have to sell it up. I think you don't appreciate the capital risk involved here.
And yes, from what others have said, your yield example is excessive.
If you bothered to read my explanation, my net debt level stays the same all the way through. So it doesn't matter if it's one, two or five loans. My total debt remains the same so my interest payable remains the same.
Even in down years there is no chance of 0 dividends from a well balanced portfolio. If anyone finds themselves in this situation they haven't got a properly diversified portfolio which is not hard to structure.
My yield example takes a middle ground. 5-6% is average, not excessive.
In a slump, there is no excess cash flow required. If you are living off he dividend income then this strategy is not for you. As per the OP question this was a how to pay off a loan faster which indicates a certain level of comfort with the loan in the first place - surely.
Sorry but your criticism is way off the mark and I'm not sure you understand a heap about the share market or this particular strategy, that should see me pay off my mortgage in 6 more years at current interest rates instead of 20 more years. Let's say I have a couple of bad years of lower dividends yields I'm still miles ahead of the guy who just has an offset and doesn't make the equity in his home work for him.
There is of course risk involved, but it's manageable and only slightly more risk than an investment property with the same structure.
i'm still riding my GFC bump…. it's almost been 10 years and I haven't made it back yet…
i.e. they don't all come back, but time is very forgiving in investing (assuming you have decades to wait)
The more loans you have the more fees you pay, the interest for an investment loan will be higher than a Owner Occupier loan. Your yield of 5% wouldn't even cover the cost of interest (assuming 4%) and fees & charges for multiple loans. You could be getting a kick back from less tax paid but you know, you need to make sure you are paying enough tax for this to work in the first place.
I wouldn't say it is "slightly" more risk, lets say it is riskier. Good luck to you and your strategy and I'm sure it can work for someone that has a lot of time to manage their share investments, and can manage a downturn better than the average market (not as easy as you think).
@serpserpserp: Wouldn't the tax payable on the dividends cancel out the deduction from the investment loan?
I don't pay any fees on either of my loans which is nice of my bank :)
Correct you need to be paying tax for this to work but anyone with a home loan will be paying tax. Of course the more the better as the tax deduction is effectively higher the higher your tax bracket.
FYI the time spent managing my shares is probably a few hours a month. Not much effort TBH. That's where a good stockbroker is worth the money.
Nope. Just my deal is fee free entirely (except an exit fee) but I pay a slightly higher rate 4.06% than I could get elsewhere. I prefer this so I know my exact comparison rate is my interest rate.
interesting.
Year 0:
Home Loan: 500,000
Share Loan: 50,000
Total: Debt: 550,000Dividends yearly: ~3000 (pump back into home loan)
Share Loan Interest (Tax Deduction) yearly: ~2000 (pump tax refund back into home loan)This is what I don't understand. Let's assume your yearly income is $100,000. This means by the end of year 0, your taxible income is $100,000 + $3,000 - $2,000 = $101,000. Meaning you have to pay tax on the $1000 you earned in dividend.
So by your example of year 0, we're under the impression that you pump ~5,000 back into your home loan where realistically it's (~$1000 minus tax) back into your home loan. You don't get a tax refund on the share loan interest if you are positive gearing.
Do i understand this correctly or am i missing something? Is is a valid strategy, all i am saying is the numbers are giving people the wrong impression.
I'm also assuming franked dividends which means the tax on the dividends is already paid by the company. Whilst not all of a balanced portfolio will be fully franked in all likelyhood, half is not a bad assumption.
As an example of my dividends in 2016 about 90% was fully franked meaning I only paid tax on about 10% of my total dividends.
That clears it up. Then this statement is misleading:
Share Loan Interest (Tax Deduction) yearly: ~2000 (pump tax refund back into home loan)
You don't get a refund of ~2,000. You pay tax on the ~$1,000 profit.
The maths is far more complex I was just trying to highlight the strategy though. The figures were meant to be obvious where there's a benefit. You pay tax on the extra income
Minus the franking credit. So it's not much extra tax. Plus you have the interest tax deduction.@Skramit: I understand. All i am trying to say is that people need to understand that the ~$2000 tax refund won't happen to pump into their homeloan since it's positive gearing.
The net benefit of investing 50k in year 0 is ~$1000 minus tax, not ~$3000 + ~$2000 like the original comment made it out to be.
@tomleonhart: Nawww you're forgetting to include the franking credits which eliminates most of the income tax on the dividends.
Taxable income assuming franked dividends would be $100000 + $3000
Less franking credit ~$1500. Less deduction of 2k = $99500 Taxable income.Tax return of extra $500 plus the 3k in dividends in cash profit means you're $3500 ahead overall.
It's bloody confusing. Haha. Who'd wanna be an accountant….
True it's not 2k as per above but I was trying to highlight without actually doing the calcs. :P
@Skramit: Wouldn't your extra tax return be $500 * [your marginal tax rate] (37% in your example), not $500?
I am assuming that the home loan you mentioned above is for your PPOR, if so how do you 'convert' it into an interest only investment loan?
You would have 2 seperate loans on a single security(property).
- 1 is PPOR
- 1 is "cashout loan".
Both loans are on the same interest rate. ATO has what they call a purpose test, if you can demonstrate the interest rate you are paying from the "cashout loan" is for investment purpose then the interest you pay on that loan is tax deductible. This is why Offset is so important.
You can split a home loan in to separate accounts. The second account could then be used for investment purposes. Or you can apply for a new loan facility from the bank or another bank altogether.
How can you use the second account for "investment purposes" when the bank gave you the money to buy a home not shares? This is where you can get stuck with tax deductibility. It's the purpose of the loan that determines deductibility. So if you were given loan money by the bank to buy owner-occupied home, and you use the money to buy shares, then you might be in trouble with the ATO and the bank.
If you can show evidence you used the second account for investment purposes I.e. A receipt of purchase of shares or an investment property that's all the ato care about.
You won't be in trouble with any bank. They have zero concern for what you use the money for as long as its legal as far as the ato goes.
Offset accounts are awesome, but they only work well on variable interest home loans. AFAIK, no lender offers 100% offset accounts for fixed rate loans. At most 40% or none at all.
Here is 100% offset feature for a fixed loan: https://www.mortgagehouse.com.au/mortgage/advantage-3-years-…
amazing! I've been looking for something like this!
Is it safe to have funds parked in offset at this institution? ie, what happens if the company goes bust? (Sorry if this is a dumb question)
Excellent point. AFAIK offset accounts are not covered under the governments deposit guarantee.
Split your loans. One portion is fixed and the other variable. The allocation would depend on how much you can offset during the fixed term period. For example if you have a $300K total loan and you want to fix a portion but also use offset, you can estimate that within 3 years you can only realistically put $200K into the offset account, then split your loan as $100K fixed 3 years and $200K variable. Interest Only.
Make sure u get the lowest rate with a offset or redraw account put ever spare $ in to the offset account so you pay less interest this is off course dependent on your personal situation.
If it is a investment property i'd say talk to your account because there is tax benefits to paying the interest and putting the money else where if it is a owner occupied property there is no tax benefit so pay off as much as you can
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Offset / Low Interest rate / Pay Extra towards loan / Fortnightly or Weekly payment instead of Monthly.