Should you pay off your home loan faster?
Mortgages are generally offered with a repayment term of 25-35 years – a chunk of time scientifically known as a stinkin’ long time. Paying interest on your loan balance every year means that over the lifetime of your loan, your interest payments can actually be almost as much as you paid for the property. Gulp.
Paying off your home loan sooner than the term agreed with your lender can drastically reduce this interest and mean you’re mortgage free sooner – which sounds pretty rad, right?
Well, maybe! And maybe not.
We’re laying out the pros and cons of paying off your home loan faster, to help you decide whether focusing on smashing down your mortgage is the right strategy for you.
Remember, any advice provided on this website is of a general nature only and does not take into account your personal needs, objectives and financial circumstances. You should consider whether it is appropriate for your situation.
Why people pay off their home loan faster
There are several benefits to paying off your home loan faster. The juiciest being that you can save big on interest. As an example, if you took out a $500,000 principal and interest home loan at 4 per cent for 30 years and made extra repayments of $250 per month every month, you’d pay off your home loan 5 years sooner and save over $67,000 in interest.
Of course, the interest rate on your loan will fluctuate over time, so you can’t ever be fully certain of exactly how much faster you’ll pay your mortgage off or exactly how much you’ll save. But if these savings sound as tasty as a McMuffin on a hangover, you’re not alone.
In addition to those savings, there are other benefits too. When your home loan balance is decreasing faster, you may notice less of a pinch when interest rates go up. The lower your balance, the lower the impact of rate hikes. Plus, once you pay off your mortgage completely, your living expenses go down, giving you more disposable income to spend, save or invest!
Disadvantages to paying off your home loan faster
So far we’ve been singing a pretty sweet tune about paying off your mortgage early. You could be forgiven for believing this is the best thing since the release of All Too Well (10 minute version obv). However, as with most things in life, there are downsides.
The biggest disadvantage of paying off your mortgage early is that the amount you’re saving in interest may actually be lower than the money you could earn with other wealth creation strategies. Plus, directing all surplus income to paying off your mortgage could mean you’re left with a home that’s paid off (yay!) but no other assets or income streams (boo!). While having no mortgage is great, accessing the equity tied up in that home isn’t always that easy.
Let’s go back to our example. You’ve got a $500,000 mortgage and a spare $250 per month. We established that paying that off the mortgage could save you over $67,000, assuming a 4 per cent interest rate and a 30 year loan term. However, let’s say invest that $250 into the stock market with an average annual return of 7 per cent. In the 30 years you’d have spent paying off your mortgage, you could have amassed over $300,000 in compounding returns ($90,000 invested, $214,000 in returns). *cue Julia Roberts algebra meme*
However, all investments carry risk. There are no guarantees on the returns you’ll get, and market fluctuations are a normal part of investing. While past data may suggest investing in the stock market can deliver a more favourable outcome than paying off your mortgage early, there is absolutely no certainty – and ‘averages’ are calculated over the very long term.
Paying off your mortgage early could result in less overall wealth but also can offer more certainty around the benefits. While you can’t calculate exactly how much interest you’ll save, you do have certainty around the amount that your principal is looking better every month.
Aargh, right? Sorry.
Things to consider
When it comes to deciding whether or not to pursue early mortgage freedom, there are a few things to bear in mind.
The interest rate on your home loan. The lower the rate on your home loan, the less that loan is costing you. Compare the amount of interest you’d be saving on your home loan to the potential earnings your money could bring in with other strategies. It really comes down to what your money would be doing if it weren’t paid off your home loan.
Your home loan conditions. Not all home loans allow you to make extra repayments, so be sure to check with your broker or lender before making a decision.
Your personal plans and goals. Number crunching is one thing, but your own personal preferences are what it ultimately comes down to. Understanding how your mortgage plays into your broader life plans will help you make a decision that makes you feel most comfortable. If paying off your mortgage is what’ll help you sleep at night, maybe that’s the right strategy for you. However, if you have a higher risk tolerance, using surplus income to grow your wealth may be better for you.
Ways to pay off your mortgage faster
If the possibility of shaving years off of your home loan and paying tens of thousands less in interest sounds grand, here are some of the ways you can go about it.
Offsets (aka Savers) and redraw. These are facilities that allow you to use savings or extra income to reduce the interest you pay on your home loan, while retaining access to the money. It’s kinda like snagging all the benefits of paying the money off your loan, without actually paying it off and saying goodbye to it forever. More about this here.
Making weekly or fortnightly repayments. Switching to weekly or fortnightly repayments can speed up your home loan pay-off as you fit in an extra four weeks of repayments each year without really noticing!
Making additional repayments. If your home loan structure allows it, you can overpay each month to chew away at that principal balance a la Speedy Gonzales.
Ultimately, Upsider, it’s your call. There are many factors at play when it comes to paying off your home loan early. Explore your options and decide what feels most comfortable to you, taking into account your goals, risk appetite, and lifestyle plans for the future.
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