Did you know that by making extra repayments on your home loan, you can shorten the lifespan of your home loan effectively saving you time and interest?
In a blog I posted a few weeks ago, I showed you how you can save money by making extra repayments on your home loan. In this blog, I want to explain how it actually works behind the scenes. If you missed that blog, find it here…
If you are on a standard variable home loan, your repayments may appear to be equal regardless of your contributions to redraw or offset accounts.
When you acquire a mortgage, your repayments are calculated at a set number – so that after the full 360 monthly repayments (30 year loan term) are made, your loan is repaid in total plus the interest accumulated over the duration that the loan is held.
Simply put, if you make extra repayments, you essentially reduce the life of the loan.
So how does this work? Consider the following example:
You have a loan that has a repayment of $1000 per month. Out of this payment, let’s say $800 is principal and $200 is interest. If you had money in an offset or redraw account, you may reduce your interest payment per month to say, $100. Therefore, the principal portion of the monthly $1000 becomes $900 and the interest portion becomes $100.
If you continue to pay your mortgage like this then you will reduce the interest payable to the lender AND you have increased your cash flow but, it is still being spread out over the full length of the loan – just at a reduced rate.
So, what happens is the banks can adjust the principal component and make it larger. For example, you now pay $900 in principal and $100 in interest per month. By boosting your principal repayments, your monthly repayment has not changed however, you are now reducing the term of the loan and also the total interest payable over the life of the loan (since the amount of interest is reduced so does the number of months you will have to pay it).
The gap, between the original $1000 per month and the reduced $900 per month after interest was reduced by a redraw or offset account, that the reduced interest caused is essentially filled with extra principal repayments which effectively shorten the life of the loan.
If you’d like to review your current loan or are interested in applying for a new one, don’t hesitate to contact me. My appointments are at no cost to my customers and are obligation free!
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