Paying Off Your Mortgage Faster

Diamonds are forever but your mortgage isn't

The word Mortgage is actually a combination of two French words: the wordMortwhich means "death",   and the word Gagewhich means "pledge". So in effect, a mortgage is a "death-pledge".Don't let your home loan be your biggest nightmare.

Banks & other lenders will generally structure a home loan for a maximum of 25 or 30 years. This allows them to maximize the interest income they will receive from you. This also allows you to borrow the maximum given your financial situation & borrowing needs.But it need not be this way.

Reducing the mortgage term, and the amount of interest you will pay over the life of your mortgage, is quite a straightforward process. By applying a few basic strategies, one can pay off one's home loan in less than the mandated time.

How is this possible?

The key principle of reducing your mortgage term is that "Interest is calculated on the daily balance". Therefore, the day-to-day balance of the mortgage account has a significant impact on the interest charged to the loan, and therefore the term of the loan.

There are four basic methods one can employ for reducing the mortgage term. You can use only one of these, or you can use a combination of several of these for maximum benefit. The first two do not require you to pay anymore than your standard repayment, and yet you can reduce your loan period. If you don't use either method 1 or 2, then the third requires only a fractionally higher repayment, which you will hardly notice, and yet it will likely shave a few years and  thousands of dollars in interest costs off your home loan.

1. Use a 100% Offset Account
2. Use a Home Equity Loan/Line of Credit
3. Make Weekly or Fortnightly repayments instead of monthly
4. Make extra payments when possible (i.e. tax return cheque / Christmas bonus)

Method 1 - Use an offset account

The 100% Offset Account method, as well as Method 2 - Using a flexible Loan/Line of Credit, use the same principle.

Method 1 still requires you to make your monthly payment and your loan will thereby be reducing over time. Method 2, however, requires a certain amount of discipline and restraint, as you need only make the interest payments.

The principle both methods employ is to funnel all of your income and savings into a facility that will either:

• "offset" or annul the interest which is charged against a portion of the balance of your loan (method 1); or
• directly reduce the loan balance upon which interest is calculated (method 2)

Most people deposit their money into an every day savings account to pay for living expenses, bills, and as a place to store savings. Banks usually only pay in the vicinity of .01% to 3% on such accounts, and you have to pay tax on that.

By putting your money in a 100% Offset account, you will be putting it where it can work the hardest for you by offsetting the interest on your mortgage - tax free!!

Let's use an example to best illustrate how a 100% Offset Account can slash years off your loan and save you $10's of thousands of dollars in bank interest.

Grant and Diana are humble battlers.

• They both work and have a combined weekly after-tax take home pay of $770 (or $3337 p/mth).
• They have a $150K mortgage at 6.7% which they have taken out over 25 years.
• Their mortgage payment is $1032 p/mth, and they share a car so they get by on $400 p/week (or $1734 p/mth) to cover all their living expenses.

They restructure their accounts in the following manner:

• Instead of having all their income go into a separate savings account, they open a no minimum amount, low/no fee 100% Offset account which they link to their home loan and organise for both their pay-cheques to go into the Offset account. Some providers require that you have a minimum balance of $2000 or so before they apply the Offset so beware and shop around (see: Conclusion).
• They also apply for a no or low fee fee credit card with a $2000 limit (enough to cover their $1734 p/mth living expenses), a minimum 30 day interest free period, and organise with their finance provider to automatically payout the monthly balance of the card from the funds in their offset account at the end of the interest free period. This is known as a "sweep" feature - it'll avoid you ever having to pay interest on the card balance as you won't need to remember to pay the card out at the due date every month.
• They then make most of their monthly purchases using the card instead of using cash.

By structuring their finances this way, they will be having their full combined net salaries of $3337 per month sitting in their offset account for the month until the credit card balance is paid out. This will be effectively reducing the balance of their home loan, upon which interest is calculated daily, by $3337 for the month.

So what difference does this then make over time? Well, assuming they set and monitor their budget so that they don't spend more than their $400 p/week allocated for living expenses, and assuming they pay all their bills via their credit card, the result will be that they will completely pay out their mortgage in 11yrs and 1mth (not 25 yrs), and will save nearly $100,000 in interest in the process.

Let's look at the stats:

    * Note: The $75,943 which has accrued in their offset account over 11yrs and 1mth time is calculated by multiplying $571 x 133mths (11yrs 1mth). They are paying their combined salaries of $3337 into this account monthly, and deducting $1032 for their mortgage payment, and $1734 for their monthly living expenses. $3337 - ($1032+$1734) = $571 p/mth left to accrue in the offset account.

If you don't like credit cards and choose not to use one, that's fine - it'll just take a bit longer to amortize your loan. In the example provided, Grant and Diana will still be miles ahead by using a 100% Offset account, even if they have to dip into their account during the month to cover expenses.

You should close all your other non-essential savings accounts and use the 100% Offset account to hold all your cash and to conduct all your transactions. You'll save on fees by not having multiple accounts, and the maximum balance possible will be working in your favour against the mortgage.

Using a line of credit or revolving credit

An Equity Loan, or Revolving Line of Credit as they are commonly referred to, applies the same principle as the 100% Offset account in that it enables every dollar of your income and savings to be used to reduce the mortgage interest.

However, it's probably fair to say that an  Equity Loan is only suitable for people who maintain a budget and STICK to it. There are three important considerations with using an  Equity Loan for reducing your mortgage term versus using a 100% Offset account:

• Equity Loans are interest only loans and have no term, hence you are not constrained to ever pay it off
• Your credit limit is normally set by the bank or lender & normally is up to 90% of the value of your home, which could be hazardous for those who are tempted to stick their hand into the cookie jar for discretionary spending purposes!
• The interest rate on an  Equity Loan is generally a little higher than for a standard fixed rate loan, maybe 0.5% , or more ,as an example

For those who are disciplined, a number of advantages apply to Equity Loans:

• You can consolidate other loans and credit cards which are on a higher rate of interest into the lower rate  Equity loan.
• They're generally portable, hence saving you on application fees and establishment costs should you move house in the future
• More aggressive or sophisticated home owners could use their equity to invest at a higher rate of return & use the returns to pay off the principal on the debt faster.
• Putting aside the features and flexibility of these loans as detailed in that article, the example we used for Grant and Diana in Method 1 would yield essentially the same result if they had used an  Equity Loan. They would still slash 14 years off their home loan and save nearly $100K in interest.
• A final word: if you spend more than you earn, then this is definitely not the option for you. Stick to a 100% Offset account.
• It's best to do a budget first and set a goal as to how much you want to have paid off the loan at the end of each year. Put dates on your plan and work out what the loan balance will have to be at the end of each month in order for you to get there. And finally, and most importantly, after setting up your Home Equity Loan, review your expenditure against your budget plan monthly.

Frequency of payments

If you're unable to use a 100% Offset or Equity Loan to help with reducing your Mortgage , and you are currently making monthly payments, then switch your payments to fortnightly or weekly. There are two fundamental reasons why weekly or fortnightly is better.

• Interest on home loan accounts is calculated on the daily closing balance. As you'll be reducing the balance of the loan more than monthly, you're creating a slightly lower balance upon which the interest will be calculated. However, the advantage of doing this will be pretty minimal.
• The main benefit achieved using this method is because you will be making an additional annual monthly repayment, and the advantage of doing this is quite significant.

You see, if you are making monthly payments, you will be making 12 payments every year. But if you make fortnightly payments, you will not be making 24 annual payments but 26.

However, for this method to be of benefit, you need to set your new fortnightly payment amount at exactly half your current monthly payment.

Beware: if you approach your personal banking manager and tell him/her you wish to switch from monthly repayments to fortnightly, he/she may use the following calculation: (Mthly Pmt x 12) / 26. If you use this formula, there'll be virtually no benefit to you.

Taking the example of Grant and Diana (see Method 1 above), the table below shows how many years the use of Method 3 will reduce off their mortgage.

By simply paying 50% of their current monthly repayment fortnightly instead, they will save nearly $32,000 in interest and 4½ years off their loan.

This method can be far more effective in high interest rate regimes, which we are experiencing at present ,and can slash many more years off your loan than when the interest rates are low .

Making extra payments

When you begin paying off a mortgage, the first few year's payments are predominantly made up of interest. In fact, in the first 14 years of a 25 yr P&I loan, you'll be paying more interest with every payment you make than principal off the loan.

If you can pay a little extra to eat into the principal, then the difference can be significant.

Let's look again at Grant and Diana. They may be unable to take advantage of Methods 1 and 2 at present, but have chosen to make use of Method 3. However, they would still like to clear their loan faster than the 20yrs 8mths we came up with in the last example.

Every year in August, they receive a combined tax refund for about $2000, and they have chosen to put this directly towards their home loan every year until the loan is paid out. The table below shows the difference this will make:

By combining methods 3 and 4, Grant and Diana will now save $66,400 in interest and slash over 9 years off their loan.

These calculations are based on the assumption that the interest rate will remain constant over the mortgage term. This is highly unlikely as we have seen in recent times. The method of saving on your mortgage will remain as explained & savings will differ as your you experience different interest rates during the term of your mortgage.

In conclusion - Your mortgage need not be forever

In conclusion, the most important element in all  strategies to help reduce your mortgage is YOU.

You can derive much benefit by using these methods, but you'll derive maximum benefit if you set targets, write out a plan and budget and monitor it monthly. Be discerning with your expenditure. We suggest using some budgeting software such as the Financial Advisor program (we can help you here)as a basic example. This will also allow you to create and calculate your own mortgage amortization schedule (as we have done for Grant & Diana). Be disciplined - it'll be worth it.

Here are a few additional tips:

• When restructuring your finances, spend the time to do some research on interest rates and fees across many lenders. Check out the smaller lenders - you may be concerned about their long-term viability, but remember that it's you that will have their money not the other way around!
• Hidden charges, fees and restrictions usually counterbalance lower advertised interest rates: quite often the lowest interest rate is not the best or most efficient loan.
• Speak to your lender about what financial packages they have on offer. By consolidating your banking with one provider, you may be able to get a fee free home loan, offset account, and credit card, as well as discounted home and car insurance. Over a period of years, ploughing the savings you make into your mortgage could make quite a difference.
• If you think you might be moving, consider a "portable" home loan (such as most Home Equity Loans). You will thereby avoid some fees (which could be discharge costs and establishment fees) when you move as you will be able to use the same loan.
• If you are self-employed or run a business in your own name and are able to, temporarily park the business cash flow in your Offset account or Home Equity Loan until it is needed. This could reduce your loan interest significantly.
• Make sure your finances are structured correctly. Some money spent on good financial advice could well be worth it. For example, if you have investment property in addition to your own home, it's usually best to put the investment property on an "interest only loan" and plough the saved principal repayments into your "principal and interest" home loan. The interest on an investment property is tax deductible whereas the interest on your own home is not( check with your accountant first). Do all you can to pay off your non-deductible home loan first, and then look at reducing your tax deductible loans. If you're in the top tax bracket, the difference over time can be quite significant.

Deposit Options

Saved deposit

5% deposit

Most lenders still need  borrowers  applying for their first home loan to come up with the first 5% of the purchase price as a saved deposit. This 5% should ideally have been saved over the last 3-6 months.This saving could have been achieved in a New Zealand based bank account or even an overseas bank account.If the savings has been achieved in an overseas bank account or has come from other forms of savings instruments overseas,you need to establish a paper trail that is accepted by lenders.

Lenders may require additional information in relation to your savings history and your current  employment. There may also be some restrictions on the type of property being purchased.

One option available to borrowers with a 5% deposit is to top it up by another 5% to make it a 10% deposit . The top-up can be by way of a gift from family or even a loan that needs to be repaid.As long as 5% is saved as required by the lender, the lender generally accepts the additional deposit as long as there is a straightforward explanation on the source.

Gifted deposit OR a “Loan”

Contribution to the deposit from family members can be in the form of a gift (this is quite common amongst Indian families) or it can be an interest-free loan. The lender has to be informed of the source of the (additional) deposit funds. Some families would elect to treat the deposit amount as a loan for different reasons. You should talk to your accountant about the possible tax implications if you are gifting a deposit. You should seek advice from your solicitor of the property relationship act and it’s affect on the gifted deposit. Your solicitor should also provide you with a Deed of Debt( if the deposit has been borrowed from family) that is generally acceptable to the lenders.

Guarantor

Close family members also have the option to act as a guarantor. Guarantors should generally be in a healthy financial position. They should currently be working or be self-employed ,and have enough equity in their property to be able to guarantee up to 20% of your mortgage. The combined value of the deposit guarantee & their mortgage should be under 80% of the value of their property. Once a guarantee of 20% is accepted, it is secured against the guarantor’s property. As a guarantor you do not need to provide any cash towards the property purchase but your property is used as security. The thing to understand here is that the new loan is set up with the lender that holds your property.

What are the Risks for you as Guarantor?

You could potentially lose your property if the new borrower/s is in arrears with their loan. It is in your interest to monitor the loan where you have guaranteed the deposit. Lenders do not like to wait but it is quite common that the borrower/s is almost 2-3 months behind in their mortgage repayments before a lender will issue a formal arrears notice. The lender should also keep you in the loop about this development. If you have been monitoring the loan, you will be aware of the situation and try to remedy it soon enough to avoid a mortgagee sale. It takes about 4-5 months of loan arrears before the lender takes the property to a mortgagee sale.

Loan Documents generally do not specify which property will be sold first at the mortgagee sale; the lender will sell the other property first as that property makes up most of the new loan value. Lenders normally will help find a solution before the mortgagee sale is reached, especially when there is a guarantor property involved. However, after selling the other property, if there is a shortfall in the mortgage arrears (which by this time will include unpaid interest, legal & administration costs) the lender will ask the guarantor to make up for the shortfall.

How do you avoid this risk? You cannot avoid this risk but can put in place measures to minimise the possibility of this happening. Our insurance advisers will talk to you about your options in this space.

What if I want to sell my house?

The Guarantor’s property will have a mortgage secured over it & linked to the other property. If you want to sell or need to sell your property, the lender can transfer the security to another property you may own, or you can use some of the proceeds from the sale of your property to replace the deposit guarantee.

How we can Help

We will ensure that the mortgage is manageable for the new borrowers. We cover possible risks for both you and the borrowers. We work with the borrowers towards reducing your guarantee within a manageable & achievable time frame.

Second Mortgages Can Help-The Mechanics

There are instances where the primary lender will allow a 2nd mortgage to be registered- two mortgages are put in place. This is very rare given the current state of the market. In this situation, the prime lender lends up to a maximum of 80% of the property value. The 2nd mortgage is for another 10% while the borrower puts in the rest. This kind of an arrangement need not necessarily be an expensive one. If the 2nd mortgage is competitively priced, this can be an affordable way of moving forward. The thing to remember here is that the 2nd mortgage has a short term (normally a maximum of 5 years) & comes at an additional cost to the borrower in terms of upfront fees & higher interest rates.

2nd mortgages are an option to consider when the main lender feels there is a risk in your loan proposal. Talk to us if you feel your profile needs this kind of arrangement.

For higher risk lending we sometimes use a prime lender for the first mortgage (the first mortgagee has first priority over the property), and arrange a second mortgage with a finance company.

The First Mortgage will be up to 80% of the property value for owner-occupied and 70% for Investment Property. The Second Mortgage then fills the gap all the way up to 90%. You will still need a 10% deposit.

Doing a Second Mortgage can surprisingly be cost effective.

All lenders price for risk. The riskier a deal, the more you will pay. If you are borrowing over 80% you will typically pay an extra 0.50% and 1.00%. This applies to the whole mortgage. With two lenders involved there is no premium on the first mortgage. There is a large premium built into the second mortgage. Second mortgages cost up to 14%pa, but you need to look at the overall interest rate and repayments before comparing to other options.

 We structure the first mortgage as interest-only so that the more expensive second mortgage is repaid first. This keeps your increase in borrowing costs to an absolute minimum.

The monthly repayments are not materially different from what you would pay normally. (In the real example above the difference is $18 per month.)

Second mortgage can be repaid as quickly as you like (including lump sums.) So after six months, if the property value has increased above your purchase price, we can consider increasing the first mortgage to repay the second mortgage.

Benefits of a Second Mortgage

You can buy now versus save and buy later.

• Second mortgages can be cost effective if set up properly.
• 2nd Mortgage Providers generally have a higher risk appetite than the bank.
• 2nd Mortgage Providers are less pedantic than banks with their lending criteria.
• They will lend even if you are using a smaller deposit (you will normally still need at least a 10% deposit.)
• The main mortgage relationship is still with the First Mortgagee who is lending at prime rates (remember that the First mortgagee has to agree to the 2nd mortgage)
• The First mortgage provider will almost always have a better product choice, pricing and accessibility than the finance company.
• The second mortgage should ideally be repaid rapidly reducing your interest costs.

Vendor Finance

Vendor Finance is where the seller leaves equity in the property (as a second mortgage.) It is a loan and must be paid back. Ideally the vendor finance is charged at a market based interest rate. Vendor Finance is trickier and only really works for people with no deposit but high incomes and no other debts.

From time to time we come across vendor finance deals. If you are interested let us know.

The market has got a bit tougher for First Home Buyers that don’t have a deposit, especially if you have other debts! One way of getting around this is using a parent as a guarantor. Another option is for the vendor to leave behind a deposit in the property.

How does Vendor Finance work?

You agree a sale price with the vendor which needs to be no more than a current registered valuation of the property. You only pay 80% of the sale price with the remainder treated as a second mortgage repayable over 5 years).

So if you buy a place for $300,000 we arrange a mortgage with a lender for $240,000.  It is interest-only to keep repayments as low as possible.  We then arrange the $60,000 vendor finance as a second mortgage that is fully repaid over 5 years.  The vendor finance will have a commercial interest rate on it of say 6.00%-8.00% so can be a nice little earner for the vendor. It is not for everyone, but if you are interested in looking at vendor finance options give us a call us to discuss. In the current housing market, some vendors are more open to exploring vendor finance. These vendors are generally holding stock that they need to offload. If you are considering vendor finance, it is essential that you get a good price, proper advice and make sure that you are not being sold a lemon.

Mortgage Payment Calculator

On this page, You can calculate your mortgage payments. This Mortgage Calculator lets you:

• modify interest rate
• calculate monthly payment based on percentage down
• get the loan amortization information
• generate amortization schedule by year/month
• receive the exact payoff date
• print calculation results on paper

 Please fill the correct numbers in following fields and click on calculate button: