Election week: it’s finally here.
I think I speak for everyone when I say it’s going to be great to see the end of the non-stop news cycle of election campaign updates.
Google is reporting that the word ‘inflation’ is being searched for more times a day than Taylor Swift.
‘Cost of living’ and ‘real wages’ have been the buzz words of the election but I personally don’t see how politicians have any more control over inflation and wage growth than you or I do.
The fact is household expenses are going up faster than wages, hence our ‘real’ incomes aren’t increasing (because our expenses are increasing by more).
At the same time, interest rates are increasing and the repayments on home loans are the biggest monthly cost that most Australians have.
Reserve Bank of Australia Governor Phillip Lowe said in a recent press conference that the Australian economy should be working toward a situation where inflation, the cash rate and our after-tax incomes are increasing by 2 per cent to 3 per cent a year.
Since the interest on our mortgages typically sits 2 per cent above the cash rate, that would mean we should be paying around 5 per cent a year on our home loans.
In this respect, we’ve had a very good run over the past few years.
If you bought a $1 million home today and put up a 20 per cent deposit, you would be taking out a loan for $800,000. At 5 per cent interest, the monthly repayments would be $4,295 per month.
That loan would take you 30 years to pay off, and you would end up paying $750,000 in interest over the 30 years (ouch!).
But with owner occupier interest rates at 2.3 per cent today if you took out the same $800,000 loan your repayments would be $3,075 per month.
It would still take you 30 years to pay off, but at the lower interest rate you only end up paying $300,000 in interest over the 30 years.
A lot of Australians who took out loans when interest rates were 5 per cent, have kept making the same repayments despite interest rates going down.
Maintaining that habit would pay the loan off 10 years early and save you more than $280,000 in interest.
In the past five years alone, you would have paid off an extra $70,000 in debt.
Just as no one can control inflation, no one truly knows when and by how much interest rates will increase.
What we can control is having a strategy for paying off our home loans as fast as possible, so that rising interest doesn’t affect us. I’ve listed a few techniques I’ve used or have observed other people use with success.
Make extra repayments
The example above paid off a 30-year mortgage in 20 years.
It worked out to be an extra $1,220 per month in additional repayments which is just under $15,000 a year.
You can go to this link and play around with your mortgage repayments – work out what they are today and what the repayments would be if interest rates were higher.
To then make it feel real you can figure out how much time and interest you can save by making extra repayments.
We all have savings accounts, and if you link your savings account to your home loan account, it can save you interest on your mortgage.
For example, if you owed $800,000 but had $100,000 in an offset savings account, the bank will only charge you interest on the net amount ($700,000 in this example).
In this example, that savings money saves you roughly $3,000 in interest a year.
That would take three and a half years off the life of your loan, and $100,000 in interest you would have otherwise paid.
As an alternative to the offset method, I’ve seen some people invest their savings in a 12-month term deposit which pays a fixed rate of interest.
As an example, if you found a way to get yourself an 8 per cent return in a relatively risk-free term deposit or similar, you would get a return of $8,000 a year on $100,000 in savings.
If you don’t have $100,000 then you could find a way to earn an extra $8,000 a year through overtime, side hustles or a second job.
If you then used that $8,000 to pay off your home loan each year, it would take eight years off the life of your loan, and $200,000 in interest you would have otherwise paid.
Using all three methods would take a combined 21 years off the life of your loan, and $480,000 in interest you would have otherwise paid.
We can’t control a lot of things in life, but we can control what we do to minimise the impact of things beyond our control.
P.S. if you’re already doing this, or you’re debt free, pay it forward and help someone else do the same (or forward them this email).