How to repay your home loan faster

In 2019 alone, average home loan amounts in New South Walesswelled by 22.2% or $112,600 more than the previous year. But as property prices are rising, wages are stagnating, and homeowners are accruing large debts that are becoming increasingly difficult to pay off.¹

Plus, the longer your loan term, the higher the total interest you pay over time. If you’re stepping onto the property ladder for the first time or already locked into a 15 to 25-year loan term, you may want to consider repaying your home loan faster, so that you can reduce your debt before it becomes overwhelming.

These tips will help you repay your loan faster, ride the fluctuating Australian property market, and take the financial load off your shoulders.

Refinance into a lower interest rate

Refinancing your home loan involves paying off your existing loan and replacing it with a new one. Homeowners typically refinance when home loan rates dip, allowing them to save money and build equity.

Refinancing is an excellent way to speed up loan repayment, especially if you meet the following conditions:

• You’re planning to remain on your property for a long time.
• You have a positive credit score (at least 760). Check your credit score here.
• You have a reasonable debt-to-income ratio (total debt of not more than seven times your annual income, preferably less).

Here are the benefits of refinancing:

Obtain a lower interest rate

Some financial advisors recommend that you refinance your home loan only if it reduces your interest rate by at least two percentage points (e.g. from 5.5% to 3.5%). However, in some cases, a one percentage point decrease is enough incentive to make the switch. After all, savings are savings.

When refinancing to a lower interest rate, you should also consider the value of your home loan. For example, a one percentage point drop will help you save more on a $500,000 loan than it would on a $100,000 loan.

Shorten loan terms

When interest rates fall, you can refinance from a 30-year loan term into a much shorter term to speed up the repayment process. However, doing so will be likely to increase your monthly payments.

You’ll also have to prove to your new lender that you have a high enough credit score and a low enough debt-to-income (DTI) ratio to afford it. Your DTI is the ratio of your total debt to your annual gross income. Most lenders won’t lend you money if you have a DTI ratio over 7 (that is, if the loan you are seeking will make your total debt add up to more than seven times your annual income).

Whether this makes monetary sense for you will also depend on how much of your home loan you’ve already paid off and whether you’re planning to move in the next few years. You can use a home loan calculator online to determine the change in monthly payments and see if this is the right move for you.

Switch from variable-rate to fixed-rate or vice versa

A variable rate home loan will typically offer lower initial rates than fixed rate home loan. However, these rates may periodically increase or sometimes even surpass fixed rates over time.

These are the best times to shift from a variable rate to a fixed rate home loan:

• When you’re nearing the end of your initial term
• When market rates are significantly lower than they used to be

Alternatively, you might decide to shift from a fixed rate home loan to a variable rate one if interest rates are falling and you plan to move in the near future. As a rule of thumb, always calculate refinance rates online or with a financial advisor and calculate loan finalisation costs.

When you shouldn’t refinance

Ask yourself, why are you refinancing in the first place?

Other than lowering interest rates or shortening your repayment terms, refinancing might not always be the best option. For example, just because your interest rate has the potential to fall doesn’t mean your monthly payments will shrink. You also need to consider how long it will take to recover the costs associated with refinancing, which average around $1,000 but can be much higher.

Get financial advice first if you’re looking to consolidate debts, save up for a new property, or take cash from equity for investment purposes.

Overpay whenever possible

Overpaying your home loan can help you reduce your interest payments in the long run. If you plan to remain in your home for the long haul, overpayments can shrink your principal significantly and provide a healthy return on investment.

Let’s say you’re repaying a 30-year home loan worth $300,000 and with a 4% interest rate. By the end of its loan life, you’d pay $215,608.52 towards interest. By adding just $300 to each monthly payment, you can save as much as $67,393 in interest alone by the end of your term. Plus, you’ll be home loan-free eight years earlier.

What you should look out for when overpaying

Though most lenders will allow overpayments during introductory periods, those who overpay too much may incur a fee of 1% to 5%. This fee covers the interest your lender will lose over the lifespan of your contract.

Overpaying can be potentially harmful to you as well. Paying off your home loan early can take away from your capital, so you lose out on savings or potential investments. You should also prioritise reducing other existing debts, which may have a higher interest rate, before overpaying your home loan.

Make regular bonus payments

If you can’t make regular overpayments on your home loan, consider funnelling extra money (e.g. your Christmas bonus, interest earned in a savings account) toward your principal at least once a year.

You can also deposit what you save on tax refunds and deductions from your business. If you’re self-employed, you may be overlooking some generous tax deductions that you can put towards your home loan. If you run your business out of your home, you can claim deductions on home office expenses, given that you dedicate a portion of your property exclusively towards business operations and meetings. Also take note of phone, fax, and internet expenses that contribute directly to business-related tasks.

Reduce payments with an offset account

Offset accounts reduce or “offset” the portion of your home loan that’s subject to interest. For example, let’s say you have a loan balance of $300,000. With a 100% offset account balance of $50,000, you’ll only have to pay interest on $250,000.

Offset accounts function as standard transaction accounts, and come in two types:

• A 100% offset account, where the total balance reduces the interest payable
• A partial offset account, where only a portion of the balance reduces the interest payable

Example: A 50% offset account with a $50,000 balance will only reduce the interest payable on a $300,000 loan balance to interest payable on $275,000.

Other than paying less interest overall, you can create hardworking savings that aren’t taxed by the ATO. Should you need to withdraw or deposit funds, offset accounts prove more flexible and accessible than lines of credit.

The downsides of an offset account

Whether this works for you depends on the type of home loan you’re repaying and how much money you’re likely to funnel into your account. Some banks will require a minimum account balance and charge high monthly or annual fees.

As much as possible, shop around for an account that doesn’t impose balance restrictions, charges low to no fees, and allows you to link multiple accounts.

Create flexibility with a portable loan

Even the most confident homebuyers won’t be likely to remain on their property for more than 25-30 years. Loan portability allows homeowners to skip the time-consuming and costly process of a full refinance on these long-term loans.

The primary benefit is that loan portability lets you save money on:

• Establishment fees, which can grow up to $1,000 with some providers
• Exit fees (only applicable if you took out your loan before 2011), which can become expensive

Loan portability can also help you avoid potential break costs, keep current home loan features (i.e. debit or credit cards and online bank accounts), and keep current lenders and interest rates.

To complete the home loan transfer, you’ll need to provide the original contract of sale and agreement on the new property. Keep in mind that while most lenders won’t typically charge more than $200 to transfer a home loan, you’ll still have to account for the costs that come with purchasing a new home.

The drawbacks of loan portability

Despite the seemingly stress-free process that comes with loan portability, it isn’t always the seamless approach banks make it out to be. If you’re looking to adjust your loan structure, loan portability often restricts the allowable number of borrowers and the interest rate.

The exchange and settlement of properties also have to occur within the same day, which can be challenging to orchestrate. Depending on your lender, you may not have to sign a new contract, but you may have to undergo a partial financial reassessment.

FAQs about overpaying your loan

Why should you pay off your loan early?

There are many advantages to repaying your home loan early. A few of them include: significant interest savings, an opportunity to contribute to future investments, and general peace of mind.

What are the downsides to repaying your home loan early?

On the other hand, repaying your home loan earlier than anticipated can pose a few disadvantages like having to pay to discharge fees. For instance, if you’re directing your earnings towards early home loan repayment, you reduce your potential retirement savings or potentially miss out on other investment opportunities.

Plus, if you repay more than you can afford, you could be depleting already-insufficient cash reserves.

How much do you save by paying off your loan early?

How much you save depends on the amount you overpay each month. For example, homeowners can save more than $65,000 on a $300,000 home loan just by paying an extra $300 every month on a 30-year loan term with a 4% interest rate.

What is the best way to repay a home loan loan early?

There is no one “winning” method for repaying your home loan early. The solution that best satisfies your immediate and long-term needs depends on the type of home loan you have, how much of it you’ve already paid off, your financial reserves, and your current interest rate.

As a general rule, always calculate whether your home loan rate will be higher or lower after you repay your existing loan. Because interest rates are historically low at the moment, a refinance may be a great option for repaying home loans more aggressively.

In conclusion

Many Australian homeowners are looking into repaying their loans as early as possible to avoid interest rates which may rise from current historic lows. However, there is more than one way to achieve this goal, so explore all your options, and preferably get financial advice, before settling on the method that’s best for you.

Article sources

¹ SMH. "Average mortgage hits $500,000 as interest rates super-charge property market, https://www.smh.com.au/politics/federal/interest-rates-super-charging-property-markets-but-businesses-wary-20200211-p53zox.html". 11th February, 2020.