When you take out a mortgage, the goal should be to pay off the least amount of interest possible, over the term of the loan. As Kiwis, we're taught to think that, in order to get ahead with your home loan, the only option is to compare the interest rates of mortgages offered by banks and pick the best one available.
But what if there was a better way?
If there's one thing we know at NZHL, it's that when it comes to home loans - it's not the rate you pay, it's the rate you pay it off.
In this article - we’ll teach you all about interest and the little known facts you may not be aware of, then show you exactly how to use this knowledge to your advantage, and shave time off your home loan.
Our best tip is to restructure your mortgage - we call this channeling and you can read about it at the bottom of the post.
- Compound interest is a killer
- Different types of interest rates
- Your rate isn't the be all an end all
- So how can I reduce the amount I'm paying?
Pay more than the minimum
Make one-off payments when you can
Make your payments more frequent
- The best way to shave years off your mortgage
Restructuring your mortgage
It’s no surprise many Kiwis feel like they’re not getting ahead because, for the first half of their loan term, they are mostly paying just interest, and reducing their original loan (principal) in very small amounts. This is because of compound interest.
For example, on a $500k mortgage, at 6% interest over 30 years, you will actually pay more interest than the original loan (principal) - paying a total of $1,080,000 over those 30 years.
Compound interest is calculated on your original principal mortgage plus total interest. Essentially what this means is you’ll begin to pay interest on your interest. It really adds up, and the only way to reduce it is to increase the speed with which you pay off your mortgage.
When taking out a mortgage, there are two primary types of interest rates available: fixed or floating rates.
With a fixed rate home loan, a bank will offer a fixed amount you will repay, over an agreed period of time. At the end of this term, you’ll get to decide whether to re-fix your loan or move to a floating rate.
The advantages of a fixed rate:
- Your repayment amount won't change
- Banks are able to compete with low fixed rates
- If market interest rates rise while you have a fixed rate, your interest won't change
However, often fixed rate loans charge fees for extra repayments, and you always run the risk of market interest dropping lower than what you’ve already fixed. Or - you might have a nasty increase in interest at the end of your term.
Opting for a floating rate means that your interest will change depending on the market, and as a result, your monthly payments may go up or down.
The advantages of a floating rate:
- You have a little more flexibility on how you pay off your loan, without penalty (we’ll talk about how this may be an advantage later in this post)
- Your interest rates may drop lower than fixed rates, making your repayments smaller
Obviously, a floating rate carries a risk of your rate increasing and therefore higher minimum payments, so you should allow for this in your financial plan.
One option that many people take is to split their home loan, to have a mix of fixed and floating interest rates. This enables you to offset the risks and the benefits.
Of course, one problem with interest rates is that they're largely out of your control, and are determined by a number of external factors. Usually, when we’re deciding what loan to go with, we’re focused almost entirely on interest rates - and as it turns out, they may not make a significant impact on what you pay.
For example, if you see two rates advertised, 3.99% and 4.05%, you would always go for the lower rate, right?
Well yes, of course, you want the lower one. But for context - the difference between these two rates is 0.06%, and this works out at a paltry $60 per year in interest for every $100,000 of your home loan. So, whilst choosing a lower rate is preferable, it is not the be all and end all.
When you calculate how much you could save by simply picking the lowest interest rate available at any given time, you’re only looking at a mortgage from one perspective - and at the end of the day, you're still left with a mortgage to pay for 30 years.
Reducing the time it takes to pay off your loan, not your interest rate, is what will really make a difference in the lives of Kiwis.
A lifestyle free of monthly mortgage payments would be a game changer for most Kiwis and provide a real opportunity to get ahead financially. Whether it would allow you to invest or save for retirement - paying off your mortgage can make a significant difference to your lifestyle.
Here are some things you can do to pay off your mortgage sooner:
Paying more than the minimum amount due each month is a great way to reduce your overall mortgage term, as well as the compound interest you’re paying monthly.
Any amount paid above the minimum comes directly off your principal, and since you’re reducing your mortgage balance – it once again reduces your interest payments.
Even as little as an extra $100 per month can make a huge difference.
Take the original loan example of a $500k mortgage, at an interest rate of 6%, over 30 years. By paying an extra $100 per month, you’ll save a grand total of $57,000 off your mortgage.
If you translated that into time saved, your mortgage term would be reduced by two years of repayments. That’s an extra two years of saving for retirement or a down payment for an investment property.
We understand that sometimes an extra $100 per month can be challenging to come up with, so a great option to reduce the principal of your loan is to make one-off payments when you can.
Every time you get a bonus from work, a monetary gift or another unexpected payment, making a lump sum payment on your mortgage will reduce the total amount of interest you pay and shave years off your mortgage.
A lot of Kiwis are under the misconception that interest rates are applied annually - but actually, interest is calculated on a daily basis.
That means that for any given day that your home loan balance is less than the day before, you'll owe less interest to your bank.
If you can rearrange your payments at more frequent intervals to the loan that has the highest interest rate, your total loan balance will be lower on a daily basis and therefore total interest costs will be lowered.
At NZHL, we have a better way to do this that helps our clients shave years off their home loans. We call it channeling so read on to find out more.
Getting advice from a professional on restructuring your accounts, combining fixed and floating loans, and channeling your income is a really clever way to save thousands off your home loan - banks don't often take the time to educate their customers about this.
We’ve used this method to reduce our client’s total mortgage terms by as much as ten years or more, depending on their circumstances. Imagine that - mortgage repayment free years, and more money to spend on what you'd really like to be doing.
You work really hard for your money, and by restructuring your finances you can make your money work just as hard for you. It's all about working smarter.
If you're interested in getting on top of everything and becoming debt free, faster than you first thought - we can help.*
Take the first step to find out the state of your current financial wellness, and if there is room for improvement.
*Subject to normal lending criteria