The benefits of overpaying your mortgage
A home loan can last from 25 to 30 years on average, which is a long time for interest to accumulate on the balance, even though the balance gets smaller each month. Anything you can do to shorten the repayment period can help quite a lot as the years roll by.
Making overpayments really pays off
If you can make overpayments of any size, whether it’s from an annual bonus, a windfall, or simply a small monthly payment from money that would otherwise go on takeout coffee, you’ll reap long–term rewards. Each dollar of your outstanding mortgage balance doesn’t just exist as part of the balance, but it’s also building up interest until it’s “cut off” by being removed as part of a monthly payment. If you can cut off some of those dollars early, then they’re no longer there, causing all that expensive interest.
The monthly payment on a principal and interest (P&I) mortgage is divided into just that – principal and interest portions. Each payment has a set amount of interest and so any extra money you pay goes straight in against the principal, knocking out dollars before they have chance to generate any more interest.
Make sure your home loan allows overpayments
So far, so good. Make some overpayments and you’ll be mortgage–free earlier, right?
Not necessarily. Not all home loans allow for overpayments, or, if your overpayments reduce the term of your mortgage, you may incur a break fee, which can be significant. Variable rate mortgages tend to be more flexible than fixed rate products when it comes to early repayments and overpayments, but it’s important to find out how extra payments will affect you.
The Freedom Lend Owner Occupier Special variable rate home loan allows overpayments and free redraws on those overpayments (with 24 hours’ notice). There’s also no early repayment fee and an interest rate of 2.17 per cent p.a. (comparison rate 2.17 per cent p.a.) on mortgages between $50,000 and $1.5 million.
If you’re looking for a fixed rate home loan that will let you make extra repayments and withdraw them then there’s the Well Home Loans Well Balanced mortgage. This home loan has an interest rate of 2.22 per cent p.a. on one and two year terms (comparison rates 2.21, per cent p.a.) and you can fix for up to five years but with higher interest rates.
Use an extra repayments calculator to see how your overpayments can help
The extra repayments calculator assumes that your interest rate is fixed for the entire term of your mortgage. You may well refinance to a lower rate at some point in the future, but the calculator gives you a good idea as to how even modest overpayments can build up over the years.
A worked example of overpayments
Imagine you have a new mortgage of $400,000 at an interest rate of 3.29 per cent p.a. to be paid over 30 years. The monthly repayments are $1,750 without any overpayments.
If you decide to make monthly overpayments of $10 each month, you’ll shave three months off the end of your mortgage and save $2,505 in interest.
A larger overpayment of $50 each month means you’re mortgage–free 16 months early and you’ll save almost $12,000 in interest.
Which is better, a lump sum or regular smaller overpayments?
You might not be in a position to make large overpayments right from the start of the loan, but then again, you don’t want to be squirreling away smaller amounts in order to make a lump sum a few years down the line.
Remember, as soon as those dollars are taken out of your balance, they stop generating interest, so the sooner they’re gone, the better. Paying a big lump sum towards the end of the mortgage means that you’ve already paid a large amount of interest already.
While lump sums can have a huge impact, if one isn’t expected any time soon, then carry on with the smaller overpayments.
Increase the frequency of your payments
Some home loans will let you change the frequency of your repayments from monthly to fortnightly or even weekly, which reduces your interest burden and the length of your mortgage.
Changing to fortnightly payments means you make 26 payments rather than 24, which adds up to an extra month’s worth of money each year. It also, as interest is charged daily, reduces the balance more frequently, depriving your interest rate of fodder.
The Reduce Home Loans Rate Slasher mortgage lets borrowers choose between monthly, fortnightly and weekly repayments. This mortgage has a variable interest rate of 2.39 per cent p.a. (comparison rate 2.44% per cent p.a.) on balances between $50,000 and $3.5 million.
Some mortgages will allow you to redraw any overpayments
There may come a time when you might need that $15,000 windfall you paid into your home loan. You might decide to renovate your kitchen, for example, or install solar panels.
If your mortgage product lets you draw down any overpayments you’ve made, then you can access some or all of the cash when you need it. Do remember, however, that your outstanding balance will be increased and you’ll add back some of the months or years you shaved off.