Written by Christopher John Rule, Executive Contributor
Chris Rule is the Founder of Mortgage Escape Australia and Co-Founder of SMARDA calculators. He owns Mindful Budget and is co-owner of Xcellerate Wealth. All companies focus on providing the tools to educate everyday people n the fundmentals of loan types and structures together with cash flow positioning.
Do you feel that you are getting nowhere with your home loan? Like you beating your head against a brick wall? Maybe you feel powerless and unable to make decisions that will help you move forward with your finances. Maybe you just don’t know who to trust!
The strategies are going to take you through how your loan works, why you’re feeling how you feel, and how you can take control.
How does your home loan work now?
Typically, we want to live in a place where we feel comfortable and not just where we can afford it. As a result, we tend to act on an emotional basis and then try to deal with the result of that decision as a “problem for another time.”
Therefore, we will borrow as much as we possibly can with as much of the income that we have to support the debt without consideration of changes of any type. Interest rate increases are front of mind, but many other “ life happens” situations also have an impact. Changes such as family additions, income changes, and unexpected costs are all things that can derail your financial peace of mind.
An example:
A couple purchases a property for (say) $650,000. They have two incomes, which are considered by the lender when approving a loan.
They want to keep their costs as low as possible, so they take the loan over the longest period available, which is typically 30 years. Let’s say, for the sake of this exercise, that their interest rate per annum is 6.5%. The bank approves the loan, places a mortgage over the asset (home), and one month later, they start to pay the mortgage, a monthly payment of $4,180. This is worked out via an amortization calculator. It’s what the bank uses to work out the term over which the loan is paid out based on the interest rate provided. Every bank does this.
So, what does that look like:
Month 1 (this is saying that of the $4,180 paid, the bank keeps $3,521 in the first month)
Month 12
Month 60
I think by now, you’re probably getting the picture and understanding why it takes 30 years to pay that kind of loan off.
Before I stop the pain, this is how long it takes in that scenario to even break even on the deal.
Month 233 (19 years and three months)
The questions are:
Has anything changed over 20 years that would affect your ability to pay?
How old would you be in 20 years’ time, still owing around $376,000?
What would you pay in interest alone over 30 years? The answer is $829,039. Remember that that is just the interest component. You also paid $649,978 in principle, amounting to $1,478,880.
The traditional solution is to pay more or pay more often(weekly, fortnightly, etc.) or pay more, more often. That sounds logical, but that extra payment has to come from somewhere in that country's living expenses.
Tips
Tip number 1
Ask your bank to provide you with a 100% offset account that runs alongside your home loan. The bank will likely suggest that unless you have significant savings to put into that offset account, it is not a profitable exercise. That’s okay; that’s not what you’re going to do.
Tip number 2
Pay every cent you got including all of your after-tax income from your employment, into the offset account. This should include any existing savings you have.
Tip number 3
Make sure you have a firm handle on the intangibles, such as living expenses. These include any outgoing other than loan payments. There are a number of platforms that allow you to see and categorise your expenses (almost) live.
Tip number 4
Create short and long-term targets with respect to accumulated savings in the offset account. Potentially, with the intent of transferring lump sums to your home loan, those targets are ticked off.
Tip number 5
Do not chase rates. Do not change banks with the sacred rebates. Once you have a strategy in place using the above tips, you will be creating your own effective interest rate. The more you keep your offset account, the less interest you pay. That’s what offset accounts do. You are, in effect, by following this type of strategy, creating an effective interest rate. You're tipping the scales in your favour so that more of your payment goes to the principal and less goes to interest (the bank). The results are dramatic. Please see the illustration below.
Remember:
All income goes to the offset account and all expenses come out of it. Everything in and everything out.
This example is based on a couple earning $100,000 & $80,000 before tax (Aus) per annum. The after-tax incomes have been combined and applied to the offset account monthly.
Note that the income remains constant, as do the outgoing living expenses. The principal and interest payment to the home remains constant, but the savings in the closing balance increase by leaving funds in the offset account. The net effect of that increase is a reduction in interest paid on the home loan.
What are the results of this particular example?
Note: no allowance has been made per changes in interest rates or incomes. Nor have there been allowances for essentials like holidays. One of the big tips that I didn’t mention in the first five is that you must allow the things you are likely to do. No matter what.
If you would like to know more or see how this might help your particular circumstances, feel free to contact me directly at 61+ 438810165 or click here.
Visit my website for more info!
Read more from Christopher John Rule
Christopher John Rule, Personal Financial Coach
Chris has developed systems and strategies to demonstrate how anyone can control the interest they pay on their mortgage. The SMARDA calculator is a web application that demonstrates that system. He has helped countless clients understand how financial products work and how to use banking products within a strategy that dramatically reduces debt by paying less interest on their loans.
His mission is to pay less for the same product.
