We have recently seen a couple of Banks advertising a concept of how to pay off your mortgage faster, whilst saving you thousands of dollars in interest paid over the term of the loan.
Well, this idea has not sprung up overnight, it has been around for, many years (well before I was around). Pay more on your regular loan instalment and save in interest repaid, not rocket science is it!
We see this situation many times, where the interest rate is reduced by the bank and the borrower unknowingly or without knowledge, proceeds with the reduced repayment amount nominated by the bank.
This practice of re-calculating the loan repayment is common by the banks as they are actually re-calculating the loan repayments over the remaining term of the loan. Hence keeping you to your original term.
Mortgage Advisers/Brokers have been advising their clients on how to arrange their loan so that they can become mortgage free sooner, saving thousands of dollars in interest paid to the bank, rather than arbitrarily repaying the loan over the term of 25 or 30 years that the loan was initially set up over. I call this set and forget mortgages.
So what I hear you say? Well, yes you do have more money in your back pocket (bank account) to spend if you reduce your loan repayments, but consider this.
If the bank reduces the interest rate, why not keep your level of loan repayment at the same amount you were paying on the higher interest rate? This will effectively help you reduce the term of your loan and ultimately save you paying thousands of dollars in unnecessary interest to the bank.
Lets use an example
Mr & Mrs Brown have a loan of say $450,000. They were paying an interest rate of 6.2% when they took out the loan over 25 years. Monthly loan repayments were $2955.
Say the interest rate has now reduced to 5.50% (two years later). Hence the remaining term is now 23 years. The new loan repayment would be reduced to $2774 per month. If Mr & Mrs. Brown had maintained their repayments at the same level on the new interest rate, then they would actually be reducing the term to 20 years, saving themselves $43,867 in interest paid to the bank.
Wow I hear you say, but wait what if they fixed their loan at 4.25% (which is a current rate). Their repayments would reduce to $2467, a savings of $488 per month. If they maintained the same repayments as they initially had $2955, they would now have reduced their mortgage to 17 years, saving $66,796 in interest paid to the bank with no additional increase in their loan repayment amount.
If their budget allowed for it and say they increased the monthly repayment by an additional $100 per month to $3055 then the situation is even better, 16 years term and interest savings of $76,288.
|Initial Loan||Bank rate reduction||Keeping payment same||Bank rate reduction||Keeping payment same||Increasing payment by $100|
|Term||25 years||23 years||20 years||23 years||17 years||16 years|
|Monthly Loan repayment||$2,955||$2,774||$2,955||$2,467||$2,955||$3,055|
There are many out there who don’t for what ever reason review their mortgage, maybe they think it is to hard, but using a Professional adviser who provides a free service may just come in handy and actually save you some real money, worth considering. It’s just the SMART thing to do.
Rohit (Rolly) Ranchhod
Registered Financial Adviser
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Information contained in this newsletter is of a general nature only and is not intended as personalised financial advice. We recommend seeking personalised financial advice from your adviser before purchasing or changing a financial product.