Did you know that the average mortgage holder in Australia is 45 months ahead in their repayments? It’s amazing how much of a difference even the smallest extra repayment can make in allowing you to pay off your mortgage earlier.
Amazingly, just an extra $50 monthly towards a typical $600,000, 30-year mortgage on a 5.85% interest rate will mean your loan is paid off 7 years and 10 months earlier!
Not only this, you would also save $20,471 in interest repayments!
In this guide, we’ll show you how easy it is to make extra home loan repayments and calculate the difference a small amount can make to your monthly payments.
How Does Compounding Interest Work?
Compound interest is the secret source that makes your bank account grow over time or your debt balloon if you’re not careful. Simply put, it is interest on interest.
Say you put $1,000 into a savings account that offers a 10% interest rate. After the first year, the balance would be $1,100 — your initial $1,000 plus $100 interest. But this is where the magic of compounding interest kicks in; in the second year, you don’t just earn interest on the initial $1,000; you earn on the whole $1,100. So, at the end of the second year, you’ll have $1,210. In the third year, you’re looking at $1,331. That is the power of compound interest.
Now, what if you’re on the borrowing side of the equation? The mechanics of compound interest work in the same way, but it’s just not so much in your favour. If you borrow $1,000 at a 10% annual interest rate and make no repayments, the same compounding effect happens — after one year, you owe $1,100; two years, you’re in the hall for $1,200; three years, you’re looking at $1,331 in debt. That’s compounding interest for you, a powerful tool when you’re saving, but it’s a necessary evil if you’re looking at borrowing to buy a home.
Now that we understand compounding interest let’s move to the real question – How much can I save by making extra repayments on my loan? How can you beat compound interest when you’re dealing with a mortgage? The simple answer is to power off your loan as quickly as you can.
Does Increasing My Home Loan Repayment Make Much Difference?
Paying an increased amount on your home loan will help you repay the loan much faster.
For example, Charlotte has a $600,000 loan and wants to make an extra $341 per fortnight on top of her existing fortnightly home loan repayment, paying a total of $1,974 each fortnight.
Incredibly, this will take 10 years off Charlotte’s 30-year home loan term and $262,060 in interest costs!
Read More: Pay Off Your 30-year Home Loan 6 Years Faster [10 Easy Tips]
Why You Should Make Extra Repayments On Your Home Loan
For every dollar in extra repayments you make, it will be one dollar less in interest you will need to pay. So, the first reason is getting your interest costs down, but that isn’t the only reason you should be making extra repayments on your home loan.
In paying down your loan, you are also increasing the equity in your property, meaning you will own more house than debt.
Home equity is calculated as the difference between the value of your home minus the loan. So, if you owed $310,000 to the bank, and your house was worth $501,000, your home equity would be $191,000 ($501,000 minus $310,000).
Making extra repayments will also help you build a buffer of savings that will accumulate in your loan and be there should you ever need them.
Read More: 7 Ways of Creating Home Equity [Faster]
When Am I Not Able To Make Additional Repayments?
If you have a variable home loan rate, you can make as many additional repayments as you would like.
On the other hand, if you have a fixed-rate home loan, there might be limitations on how much you can make in additional repayments.
Some banks will allow you to make up to $10,000 per year in additional repayments, while others will not allow any additional repayments during the fixed rate period. If you would like us to check what your bank’s requirements are, get in touch, and we will confirm.
Fixed-rate home loans are great for people who want stability and to know what their repayments will be over a set period, but they aren’t great if you are looking at making extra loan repayments.
Read More: Which is the best type of home loan for me?
What Counts As Extra Repayments On A Home Loan?
When you take out a home loan, you will be given a contracted term, which generally ranges from 25 to 30 years.
In other words, the bank will calculate what your principal and interest repayments should be each month for the next 25 to 30 years using something called an amortisation schedule.
Using the loan amount, interest rate and loan term, the bank will determine your monthly payment from today until it is fully repaid in 30 years’ time.
In this example, if John took a mortgage of $600,000 today at a 5.85% interest rate and made his minimum repayments of $3,540, it would take him 30 years to completely repay the loan. Over this period, he would pay $674,270 in interest to the bank!
If he started making an extra $200 per month in repayments straight away, his loan repayments would be increased to $3,740 per month, and by making this small difference, he would save 3 years, 9 months from his loan term AND $102,369 in interest costs!
Even if you’ve had your loan for a few years, it isn’t too late to start making extra repayments. For example, if John had his loan for 5 years and only then started making an extra $200 per month in repayments, what would the difference be?
By starting to make extra repayment contributions after 5 years of $200 per month, he would still save 2 years and 9 months from his loan term AND reduce his interest costs by $65,031!
Is It Possible To Use My Offset Account To Make Higher Payments?
A home loan offset account helps you reduce interest costs because every dollar in your offset account reduces your home loan balance by the same amount. So, additional repayments to your offset account will have the same effect as an extra repayment!
If you can be careful with your money it can be better to make the extra repayments into your offset account because it can be easier to access the funds compared to redraw.
But at the end of the day, an offset and redraw account do the exact same thing.
As you can see from the example above, if you had $20,000 in the offset account (or in redraw), it would reduce your home loan balance by $20,000, which means you are paying interest on a lower amount.
In this case, you would only pay interest on $130,000 (instead of $150,000)!
If you aren’t using an offset account, you can chat with our team of home loan experts to see if it would be beneficial for your situation and how much faster it could help you pay off your loan.
Read More: What does a 100% offset account do?
Increasing Your Repayment Frequency To Pay Off Your Loan Quicker
Out of everything, this is possibly the simplest AND most effective tip we can give you…
(The bi-monthly trick)
Most banks, by default, give you monthly repayments. So, in a year, they will assume you make 12 repayments.
Let’s say your monthly repayment is $2,000.
In a 12-month period, you will make $2,000 x 12 months = $24,000 in repayments. Simple right?
If you switch to bi-monthly (also known as fortnightly) repayments, you will make an extra 2 repayments without even realising.
So you make a $1,000 payment ($2,000 divided by 2) every fortnight, which there are 26 per year = $26,000 per year in repayments!
You will make an extra $2,000 in repayments per year without even realising AND save 4 years and 4 months from your loan!!!
Read More: Pay Off Your 30-year Home Loan 6 Years Faster [10 Easy Tips]
How Many Years Does It Normally Take To Repay A Loan?
The banks will give you a home loan with a standard loan term of between 25 to 30 years.
There are some exceptions depending on your age, where the bank may require you to reduce your loan term. However, in general, the banks will give you a default loan term of 30 years and assume you will not make additional repayments. This is why you should look at the extra repayment calculator to see how many years you can save from your loan term!
Read More: 7 Ways of Creating Home Equity [Faster]
How Many Years Will It Take To Repay A Home Loan With Extra Repayments?
The total time it will take you to repay your home loan will depend on a range of things, including your interest rate, loan balance, repayment frequency (monthly, fortnightly, weekly), the extra repayment amount and when you start making additional repayments.
Broadly speaking, the more you make in additional repayments, the sooner you make it will help you pay off the home loan faster.
When Is The Best Time To Start Making Additional Repayments?
As you have seen from the examples above, the sooner you start making additional repayments, the faster you will pay off your home loan. The table below shows how much money and time you can save by making extra repayments:
Extra repayments start | Interest saved over the loan term | Total time saved |
Immediately (0 years) | $102,357 | 3 years, 10 months |
1 year | $93,980 | 3 years, 7 months |
2 years | $86,076 | 3 years, 4 months |
3 years | $78,623 | 3 years, 2 months |
4 years | $71,615 | 2 years, 11 months |
5 years | $65,031 | 2 years, 9 months |
10 years | $38,009 | 1 year, 10 months |
15 years | $19,511 | 1 year, 2 months |
Figures calculated on a $600,000 loan amount, 30-year initial loan term, 5.85% interest rate and extra contribution of $200 per monthly payment.
Does My Interest Rate Affect My Extra Repayments?
Switching to a lower interest rate can make a big difference in what you pay on your monthly repayment and how fast you can repay your home loan.
Generally, more than half of your monthly repayment interest, so the interest rate makes a big difference.
Let’s say you owed $450,000, had 30 years on your loan term, were paying 4.50% interest and had monthly repayments of $2,280.
If you were to switch to a lower interest rate of 3.69% (using ASIC’s Moneysmart calculator) and maintain the previous monthly repayment of $2,280 (even though your repayment would drop by default as the rate is lower), you would actually pay off the loan 4 years faster (55 months) and save $127,470 in interest costs!!
The difference is MASSIVE.
Read More: 7 Reasons to Refinance your home loan
How Much Should I Make The Extra Repayments?
As we’ve covered, the more you can afford to repay, the less interest you will pay, and the faster you can pay your loan off.
But the amount of your extra repayments is really up to you and what you can afford.
We’ve done some numbers below based on a $600,000 home loan over 30 years to give you a bit of an idea of the difference other amounts make on your repayments.
Extra Repayments per month | Total interest savings over the life of the loan | Total time saved over the life of the loan |
$100 | $55,969 | 2 year 1 month |
$200 | $102,369 | 3 years 7 months |
$300 | $141,602 | 5 years 4 months |
$400 | $175,329 | 6 years 9 months |
$500 | $204,695 | 7 years 10 months |
$1,000 | $309,311 | 12 years 3 months |
Need Some Help Crunching The Numbers?
Are you ready to make some extra repayments but don’t know where to start? Our team of home loan experts is here to help you!
Unlike other mortgage brokers who are just one-person operations, we have an entire team of experts dedicated to helping make your home loan journey as simple as possible.
If you want to get started, please give us a call on 1300 088 065 or book a free assessment online to see how we can help.
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