Making extra repayments can free up your debt quickly, leading to financial freedom and allowing you to invest in other assets.
As we all know, debt accumulates interest. The longer the loan term, the more interest you pay. Paying up over and above your repayment schedule reduces your principal, not only reducing the loan term, but saving up on interest as well. Simply, pay more to save more.
Rebecca and Nat recently bought a villa for $2.5 million. Making a deposit of $500,000, they initially decided on a loan of $2 million for 25 years at a variable rate of 4.90 per cent per annum. However, taking a dear friend’s advice, they compared deals online and chose a loan with all the desired features at a variable rate of 4.75 per cent. This change will potentially save them $51,967 over the life of the loan.
Using an extra repayments calculator available online, they calculate that by paying just $1000 extra per month, the loan term gets reduced by three years and seven months, and they save $227,926 in interest.
Time-tested strategies to reduce your home loan
Pay more frequently: Paying fortnightly instead of monthly means you would make 26 half payments per year, or 13 full payments instead of 12.
Make lump sum payments: It is a good idea to make lump sum payments towards your loan whenever possible, especially in the initial years, as it can considerably reduce the principle amount of the loan and also reduce the interest.
Make larger repayments: Larger repayments mean more of your money is applied towards the payment of the principle due. Lesser the principle, lesser is the interest.
Open an offset account: Having an offset account can reduce the interest you pay on your loan. For example, if you have $1 million in an offset account, interest on a $2.5 million loan would only be calculated on $1.5 million. Considering that the interest payments contribute to the longevity of your loan, having an offset account linked to your loan can substantially reduce the interest as well as the term of the loan.
Making extra repayments regularly can significantly cut short the life of your loan. Plan your repayments smartly to gain financial freedom early.