I'm looking around at the idea of buying my first home but the sheer amount of interest you pay on a 25/30 year home loan puts me off at the moment.
I'm interested to know the way people reduce the amount of interest they pay. The most obvious is to pay it off sooner but after doing calculations it's not going to be an option for me at the moment.
Excuse my ignorance but I'm completely new to the whole thing.
You negotiate a home loan that includes a linked savings account. You get your pay deposited directly into this account. However the interest is not paid to you but goes to reducing your mortgage. You save in two ways, the reduction due to the interest, and not paying tax on the interest. It may not be much but every little bit helps.
Also if the mortgage has a redraw facility, this allows you to keep less in your savings account for emergencies.
I really like this idea in theory. However I found that the options that offered this also came with a higher interest rate and/or fees which more than offset my savings, even with a reasonable safety balance outside of the home loan.
So if you can get this for no extra, great, but I found that better deals can be found without it.
The amount of interest you pay on the loan initially is about the same (slightly higher) as what you would pay in rent for the same property. The difference between rent and a mortgage being that your rent increases every year but your mortgage interest payments decrease every year.
Some example figures:
$360,000 home.
Monthly mortgage repayments = $2100 (interest $1850 + principle $250, initially, but ratio decreases with time)
Monthly rent = $1600
Keep in mind that if interest rates stay the same your monthly mortgage payment will always be $2100 even in 30 years from now. Obviously rent will not stay the same for 30 years, it will be exponentially higher.
I found this site very useful, www.onthehouse.com.au and found that ME Bank and Bankwest offered pretty good loans/interest rates.
Is it possible to borrow in asian countries like Singapore where the interest rate is really low? I would think not, if not every Australian will be doing so.
When you take a loan with a bank you have to offer collateral, i.e. something they can seize and sell if you fail to pay back the loan. How would a bank in another country, that doesn't not have any operations here, be able to take your home as collateral?
How are you managing the exchange rate risk? When AUD depreciates, the value of your loan goes up.
Take into consideration all fees associated with various mortgages, ie the comparison rate
So so true….and there is no way you can know all this when you take out a loan.
St George added fees to my home loan years after it started ( i don't know why that is even legal)
but i was happy when i paid fortnightly helped drop the term down)
My advice on your first home loan, and I cannot stress this strongly enough, pay every single spare cent you have off the principal; especially in the first 5 years!!! The repayment schedule is structured such that most of the mortgage payments in this time are primarily interest, with minimal principal content. This is the time to make your impact on the loan balance, and therefore ongoing interest!
Of course have a redraw facility for emergencies as others have noted, but resist the urge to use this money to live large…IME the people whose loans stagnate, go backward, or even default are those who use equity to keep up with the Jones's. It's so common to want to have the pseudo-4wd, Harley or boat in the driveway in your new housing estates…I wish I had a dollar for every one of these scenarios I've seen where these kind of folks have had to sell up & bail out because they're too far in hock when there's an economic downturn or something significant happens.
Same goes for those who choose to put in a pool or do some fancy renovations too soon…these are great investments long term; however, unless you're specifically on a renovate/resell/upgrade pathway this can be false economy in the first 5 years.
Also, make your repayments as frequent as possible, this will also reduce your principal more quickly & reduce the interest charged. There's heaps of mortgage calculators out there that will show you how much of a difference even adding a mere $100 to each weekly, fortnightly or monthly mortgage payment will make to reducing the term of the loan…compound interest is an amazing thing, you'll be staggered by the difference it makes! :)
+10 for everything StewBalls wrote. Other things you can do:
Reduce your super contribution for the first few years to pay off the mortgage but don't forget to take it back up again after.
If you are paid fortnightly, then pay your mortgage fortnightly. If you can, arrange it so that it goes into the mortgage ASAP after your pay.
To take this even further, the way I do it is to have no fixed payment schedule at all to the loan. When my pay comes in I review the balance and transfer all that I can into the loan.
Requires more management and control, but helps get every cent on to the loan quickly.
I totally agree with StewBalls. Going back to the 1980’s when my wife and I had our first housing loan it was at 18%, which was normal then. We were advised by a friend exactly what StewBalls said, it was the best advice that we were ever given. We were both working and her pay went straight into the mortgage, mine we lived on. We struggled and fought because we were poor doing what we were doing, but after 9 years we had paid our house off. If you can work overtime, do it, a second job, do that too. Your life will change when you own your own home. Good luck
Also be alert to any opportunities to switch lenders during the term of your loan if calculations show a gain if you do. Though lenders try to introduce friction with exit fees and such.
Thanks all! A lot of useful information.
If you're genuinely concerned about the amount of interest then I would buy NOW. It wasn't all that long ago interest rates were several times what they are now. As high as 18% I believe. I'd suggest setting up a spreadsheet, or even just pen & paper - and write down what rent you pay - and how much loan repayments would be. If loan repayments are less or only a little more, etc. than your rent… it's a bit simplistic, but you get the idea.
If you do it, get your loan anywhere - who cares - then switch to another lender with a lower interest rate. I say this because there are some lenders who wouldn't consider you, but once you've been through the approval process elsewhere - suddenly they have no problem switching you over. It's like they rely on the fact you must be able to service the loan, or the other bank wouldn't have given it to you - so suddenly you're "safe".
POI - the other day I noticed CBA variable interest rate is about 1.5% more than UBank. But you can't get an initial loan with UBank - you have to get the loan elsewhere first, then switch to UBank.
BTW. You said it wasn't an option. Don't rule anything out. What I mean is, if you can't buy to live in yourself, maybe consider buying somewhere else where homes are cheaper - and check out how much rent it would bring in. If the rent coming in is more than the repayments going out. You can also put some in yourself. The person renting from you is paying most of your loan. Later sell it and use as a deposit, or keep and use as collateral for your own home.
Oh - and never "fix" a loan. They say people that take variable interest rate loans nearly always come out paying less. This is especially true now, while interest rates are heading down. Who would want to fix their interest rate for 1,3,7 years etc. then variable loans drop again. If anything, get variable first and then lock in once rates start climbing. The only reason I can see to use fixed is to be certain how much your repayments are. But in my opinion (which admittedly may not count for much), if someone doesn't know if they can handle increased repayments if rates go up by a few %, then they shouldn't be getting a home loan in the first place.
Others have already mentioned the main way to save on interest - offset account (or a redraw facility, but often there's a charge every time you withdraw). But try to get a 100% offset account (not 80%, 90%, etc.) AND check it directly reduces the principle. (I've read some loans only reduce the INTEREST you're liable to pay each month, instead of reducing the PRINCIPLE.)
i.e. If you still owe $100,000 and have $1000 in your offset account, the lender considers you only owe $99,000. So the interest you pay is calculated on $99,000 instead of $100,000. Yet you still get to spend the $1000 when you want to.
Additional tip I (sort of) learned from budgeting books and modified to suit us is - to "pay yourself first". They usually explain it like this…
Someone spends what they earn each week. They think, "If only I made another $40, I could start saving." Then they get a $40 raise. But they suddenly spend the extra $40 too. In other words they adjust their spending "absorbs" (adjusts to) their income. The books go on to say this works in reverse too. That if you put away 10% of your income as soon as you're paid, your spending will adjust back the other way so you don't miss it. (You put it in a separate account, so you don't think of it as money to spend.)
I added to their idea. Once you've adjusted to your "lower income", why not take another 10% and repeat.
I comment on your interest rate observations:
The interest rate is VERY VERY low right now. This is great but be warned: It will go up! It may take years, but it will. If you NEED the current rate to handle the loan, then you are borrowing to much. Ensure that you have enough margin to handle a rate increase.
i've been in banking for 12 years now.
There are a few certain truths when it comes to banking and lending.
The cheapest interest does not mean the cheapest loan. Many will say to look at the comparison rate but even then it still won't be the cheapest loan. Packaging all your products will give you the cheapest price. In a package you will generaly get your everyday banking accounts for free, anual credit card fees waived, 15-25% off Home and Contents Insurance etc
One common myth is that banks make the most money out of their mortgages. Not true. The profit margin on deposits or unsecured lending ( CC's and Personal loans) is generealy 5-10 times higher then a Home Loan. Hence you will get a better deal when you package.
The person/lender completing your Home Loan application is almost as important as the product itself. There is nothing more dangerous then an incompetent lender. Most lenders will do their best to get the best and most affordable loan for their customers, however there are a few out there that just don't do the right thing and flog products that customers don't need.
Always take out some type of mortgage protction to covers your payments in case of unvoluntary uneployment or illnes. the average loan in Melbourne is around 400k-500k with an average repayment between 2k-3k per month. arrears of 6k will get your 5000k house taken away from you.
you will pay 75% of the total interest within the first 50% of the loan term if you only make the bank reqiored repayment. more money more often is the key to rducing your interest. 100% offset facility is great way to get rid of interest. But is paying off your house in say 10-15 years worth the sacrifice you will make in your social life? 400k mortgage paid off in 15 years will cost you $1000 extra per month. Are you happy to sacrifice holidays, nice cars, entertainment while you are young only to be able to do that when you are 40? each to their own i say.
It's a great idea to shop around. Do your research online or over the phone and narrow down the banks/products that you like to 2. Decide on what is the best rate and fee structure that you think is fair. Go into the branch and ask to speak to the lender. Be clear that it is between them and only one other organisation and the reasons why you made the choice. That way the lender will not feel that they are wasting their time with a rate shopper that will never go with them but are only using them to get a better rate with their current banking provider.
"You can live to be a hundred if you give up all the things that
make you want to live to be a hundred."
-Woody Allen
I don't think #2 is a myth - but that's only my opinion. After all, if there was not money in it banks wouldn't do it. Second, while credit cards have several times higher interest, a home loan can take 25/30 years to repay. Not many people will still be paying (the same) credit card debt 25 years later. i.e. It may take longer, but surely banks must make more from loans in the long run?
[Edit: Why did the above come out in bold!?]
a. Holiday in Fiji.
b. Never buy a new car. (I've read several "wealth creation" books where the wealthy authors admit to buying modest second hand cars. i.e. Instead of making themselves poor with loans to appear rich, they live a bit more modestly to actually become rich.
c. And entertainment… well, that's what things like bittorrent & filestube is for, ha! ;-p
Off-topic.
Edit: Why did the above come out in bold!?
When you prefix a line with a hash # it becomes a heading hence bold.
I wouldn't swear off buying new cars, it depends on the price and what your priorities are.
My $20k Mitsubishi has 5 years warranty / 10 years engine. How many used cars are going to last 10 years without major work? It also has 5-stars safety, which is paramount for me, used cars often have far less.
Showing up constantly late to work and losing your job because your car has konked out and needs repairs you can't afford, that's a non-bargain!
Well, I don't many NEW cars can last 10 years without major work either, but that's another story. ;-p But if someone buys a $3000 car instead of $20000, that's a lot of repairs before they "lose".
It's not difficult to find great cars. It just takes patience. I bought an early 1990s car on ebay with 20,000km. I overpaid because I wanted it. But even so, it was $10,000 when it cost $40,000 new back in 1991. Back then that could have bought a 3bd brick house around here.
I've seen many similar cars on ebay. I watched a Ford Falcon "Sapphire" sedan with similar kms sell for $7,000. Also lots of great restored cars, that are simple and cheap to repair.
If people want to buy new, of course that's their choice. (Good on them too - it leaves the reliable used cars for other folks like me!) I'm just stating a pattern I've noticed in wealth creation books. Wealthy people must do things differently to most of us. I think there's wisdom in living frugally to become wealthy, rather going into debt to appear rich today (to try and impress other people who don't care anyway). That only makes the banks wealthy instead of me. ;-)
Point no.5 is a very good point. I know it goes against what this topic is all about, but you shouldn't sacrifice all fun in life on an obsessive quest to become debt free as soon as possible.
It's all about a balance I guess .. don't live on the edge such that you are on borderline bankruptcy, but also don't have a boring existence just so you can squeeze every last dollar into the loan.
But is paying off your house in say 10-15 years worth the sacrifice you will make in your social life?
Social life? What social life? :)
But seriously it helped that I didn't have expensive habits to start with. I was happy with the occasional trip to the cinema and I didn't pass up an outing with friends now and then.
Some good info here guys
Simpliest way I see to reduce the amount of interest paid over the term of the loan is by reducing the amount that you borrow. By either buying something lower priced or having a larger deposit.
If you manage to get 20% deposit you can also skip mortgage insurance which is around $7k on a 300k property.
If you have the option you can move back in with the olds for a year or until you find a place. If your paying $300 in rent and it takes you 6 months to find a place you save $7k just in rent. Add power/net etc and its a bit more.
Another bonus is you will probably use atleast 1-2 boxes of crap that you can flog off on ebay.
That can be good advice if you have the option (many don't though), just don't let the market pass you by…
Offset account is the most important structure to reduce interest and pay off the loan quicker. Whatever you deposit to the offset account "act as" paying off the principle.
Also get credit cards and use its interest fee period to your advantage. Pay for your day to day expenses on the credit card and settle it just before the interest free period ends, withdrawing money from the offset account.
I've heard of the trick below; but haven't tried it out myself.
Credit cards offer "interest free"/"very low interest" promotions from time to time when you transfer the balance from another credit card. eg. No interest for 6 months.
If you have such an offer approved, withdraw money from your current credit card (say $10,000) and deposit it on to the offset account. Then transfer the balance to the new credit card and not pay interest for the 6 months. At the end of the term, settle the credit card balance with another similar offer or by withdrawing from the offset account.
I would tend to agree, credit cards can be a very volatile thing; and jumping them from lender to lender to take advantage of balance transfer deals is contingent upon far too many variables to be a really safe bet IMHO.
Plus, don't CC providers treat cash advance balance transfers differently to purchase balances?
I was under the impression that you couldnt put home loan repayments on a credit card.
I looked into it (granted it was ages ago and maybe it was because it was an amex) they wouldnt do it. The only way it was possible was as a cash advance which more then negated the double points scheme
They said it was something like the fee's made it "not profitable"
I was under the impression that you couldnt put home loan repayments on a credit card
This is correct.
What you would do is to get a cash advance on the credit card and deposit that on the home mortgage. Cash advances incur interest from day one (no interest free period), so you would do this when you can roll over the debt to a new card that does not charge interest when transferring the balance.
Check this:
http://www.creditcardfinder.com.au/balance-transfer-credit-c…
(I haven't done this my self)
You do have to be careful on this tactic. My mortgage broker told me it showed up on my credit file that I had had 4 credit cards in the last 5 years and that it didn't look good even if I have never paid interest on a credit card in the 20 years I have had one.
"but the sheer amount of interest you pay on a 25/30 year home loan puts me off at the moment."
I don't see the "sheer amount of interest" you end up paying on a 25/30 year loan as an issue, if you can keep up with the mortgage payments in the first few years, because, in general, the value of the property will grow as well. It is not like when you invest in a depreciating asset (eg. like a car).
Great advice here. As someone who finally paid off my mortgage this year I wish I've followed some recommendations here. 25/30 years mortgage might sounds daunting at first, but do remember that (1) the interest portion of the payment reduces over time, and (2) your wage/salary/income will hopefully increase over time due to inflation and promotions. So do remember put in that extra bit of money from salary increases and bonuses each year to pay off the mortgage faster.
Congrats on smashing the mortgage monkey scotty! :)
Thanks. I think the difference is more than financially but also psychologically. I hate to be in debt.
A few key ideas (many of which have already been mentioned).
Good luck.
Would you mind to also post the rules that apply to investment property?
One questions guys… if i have extra 10k in my bank account.. what is better? To pay it off towards the load or to keep it in the offset account..
as of now its in my offset account so i am anyways not paying any interest on that amount..
TIA
If you don't need the money, then doing the sums, I would say it's better to pay the mortgage because that will reduce the principal by ($10k - mortgage interest on principal owing). If you put it in the offset account, you only get (offset interest on $10k).
However you may want $10k for an emergency. That's why redraw facilities were invented so that you can pay off the mortgage and still have access to the money in an emergency. Stress on emergency, not splurge.
thanks mate.. yeah i do have a redraw facility as well.. so i can take it out whenever i want..
what difference does it make if it is in offset or paying the principle?
so long as you have a 100% offset facility, there shouldnt be any difference
say you owe 100k, with 10k in a 100% offset, you are only charged interest on 90k.
Don't underestimate the motivational (psychological) factor of paying it off the principal either. As scotty said above, seeing that number (debt) going down can be a powerful motivator for many people…myself included!
If you have a free redraw facility (as I do), there is little practical difference…
That said, for some people who are salary sacrificing or using the mortgaged property as a SFSF, there can be tax implications for redraws IIRC, so you really need to speak to your lender/accountant if this is you! ;)
[edit] You took the words right out of my mouth… :)
understandable with the psychological factors.
i guess it depends on whether it is a place of residence or an investment, that is probably the only factor that makes a difference
i had a quick chat with a guy who is a financial consulatnat.. he said if u pay off the extra 10k you have the option of asking the bank to restructure your loan so ur installment will come down…
or i can leave the installment what it is.. & that ways i am putting a little extra towards the principal every month..
he said one advantage is u can access ur money anytime in offset but that i not an issue… what i want to know is which way is better or both are same..
still not sure which way to go..
@greenposseum… in both cases my installment is same right?
Why don't you do the sums like I showed you and compare the principal in both cases? Usually you receive less interest in offset than you pay in mortgage unless it's 100% offset. If 100% offset then there's no practical difference, it's like you took a redraw ahead of time.
@coolhead,
Don't reduce your installment if you want to pay off your loan quicker…hence this quote from blaircam above:
If your rate drops - do not drop your payments. Paying only the required minimum is a recipe for enriching the banks
@greenpossum - Thanks & yes its 100% offset
@Stewballs: Thanks, thats what even i intend to do and currently doin as well..
When we took out our loan recently the interest rate was 6.08 percent. We figured if we calculate our automated minimum fortnightly payments at 7.50 we could totally forget about worrying about interest rate shifts for the time being.
Lots of valuable information here! What would you do if you have let's say 50K in savings? Will you put it into an offset account/pay the mortgage or will you get a second property? What are the variables that I have to considere in there?
The second property does not get the special tax treatment that your home gets, remember that. Unless somebody else owns it, e.g. your child.
Sorry but what do you mean by "special tax treatment"?
Second and subsequent properties are considered investment.
… which is subjected to CGT when you sell them. But then the interest you pay on your IP can be claimed as expense against your main income, ie negative gearing.
Best to ask a financial adviser especially when you need to look at your financial situation as a whole.
Right, the First Home Owner Grant.
More than just that. You are not charged CGT on your main (not necessarily the first) residence. You should talk to a financial adviser if you are not aware of these implications. Or at least look at the ATO website. E.g.
@scotty what is a reasonable price to pay for a financial adviser? Last quote I got was around $1500, which is a bit to steep for me I think.
@5h4rk — no idea. I've worked with financial advisers and planning groups for the majority of last decade, and prefer not to talk to them for a while :)
Thanks!
Quick question about IP's: Say your repayments to the bank are $500/week and you get $400/week rent. If that $500/week is going towards capital and interest, does that mean that you cannot claim a $100/week loss at tax time? (let's say for example the $500 breaks down into $300 interest and $200 capital)
If you can claim capital repayments as a loss, does that mean you can pay extra, say $700/week and claim a $300/week loss on the property (i.e. negative gearing?)
Capital repayments cannot be offset against income. Otherwise everybody would be taking advantage of that to buy property. See http://en.wikipedia.org/wiki/Negative_gearing_(Australia)
Edit: Also, due to this situation, it's often that owners of IP don't want to pay off the capital quickly but use the interest repayments as a deduction.
What is the point of having an IP in that case? Might as well just put any spare cash into your own residential homeloan.
If you are just paying interest only on an IP, and the property price goes nowhere, you would have lost because although you can use the loss on the IP to offset the tax, it's still money you paid to the bank…
The only way you win is if house price rises right? Or am I missing something!?
Exactly, these owners are betting that the value of the property rises. It's just another class of investment with its own risks.
The only way you win is if house price rises right?
What?! You mean the house price doesn't always go up?!!!
<Sound of my deck of cards crumbling down>
Has there been any case where property rent decreased in the history?
I'm sure there has but it is very very very rare and probably only went down $10 or $20.
I am sure some time later it was probably back to normal or above that reduced rent. (Much like house prices….)
Also IP owners often get Interest only Loans, so that just claim all their payments to the tax man. The reason for this is if they have a normal home loan, then any additional money is better off that loan than the IP.
I have had both fixed and variable and I've won some and lost some, it all depends on the future.
As another poster typed fixed rates are usually lower than variable rates, and they are also good if you want certainty.
Also, I've never looked at it, as how much interest you have to pay over 25/30 years as I've never owned for more than 6 years, and I'm up to property 5.
Ok I would like to ask this about a mortgage. I have an offset account and my salary goes in fortnightly, my interest payment comes out monthly. I have asked the bank is there a better way to do this but they say no, but I am not sure? Is this the same as paying fortnightly? thanks
Banks will move on the interest rates FYI. Mines .25% lower then the advertised/listed rate after getting a interest rate match :)
Don't ever go to a full line of credit unless you are the stingiest person around! :P
Offset with f/n repayments would be my suggestion. Packages are great I found.
Lastly, don't drop your repayments if the rates go down… if you can afford it keep your old level of payments.
You know about offset savings accounts, right?