A lot of attention has been focused on how to get finance, so homebuyers and investors can get into the property market. Less attention has been put into showing how mortgage finance can affect your personal finances.
Take for example. Can you answer the following two questions?
How much interest have you paid on your home loan?
Assuming you don’t refinance or top up your mortgage, how long does it take to pay off half your home loan?
A lot of homeowners can quote you the interest rate. Fewer can tell you how much interest they have paid over the course of the loan. Even fewer can tell you how long it takes to pay off half their home loan.
Let’s take a look at the numbers.
Assume you took out a fully amortising 30 year, $500,000 home loan, with an average interest rate of 5%.
Your fortnight repayments would be about $1238 per fortnight.
After 10 years, you’ll be TEN years older, and you would have paid $321,938 to the bank. Roughly, $228718 is interest while only $93220 would go towards reducing your mortgage.
So you loan balance outstanding would be about $406,780. That means you would have paid off less than 20% of your home loan.
After 20 years, you would have paid in total $643875 to the bank. Roughly, $397030 would be interest while $246845 would go towards reducing your mortgage.
So after nearly twenty years (assuming you don’t refinance and top up your home loan), you would have almost paid off half your home loan.
After 30 years, you’ll be THIRTY years older and have paid a total of $965,640 (almost a million dollars) to the bank and almost half of that amount is interest. Interest comes to a whopping $465640. WOW!
But what can you do? Well, you can reduce the term of the loan to 25 years. Assuming the same information above: $500,000 home loan, with an average interest rate of 5% making fortnightly payments.
For example, you can increase your fortnightly payments by $110 to $1348 per fortnight. If you do that, you can reduce the term of the loan to 25 years. Then after 25 years, the home loan is paid off. In total, you would have paid in total $876,200 to the bank. Only $376,000 is interest.
That means by increasing your fortnightly payment by $110 in this example, the home buyer could reduce the term of the mortgage from 30 years to 25 year. In the process, the homeowner would end about paying $89,640 less in interest, with a 25 year mortgage compared to a 30 year mortgage. All else being equal. With that amount of money saved, you can get a pretty decent European car with $89000.
So next time, you negotiate your home loans and work out your mortgage finance, don’t just focus on the mortgage interest rate and loan fees. Structure the loan so it works for you. If it makes sense to reduce the loan term by increasing your mortgage repayments slightly, then do so. If you got no other investments to park your cash, in the long run, you may save paying a lot of interest.
As always, examine all your options and speak to a financial advisor if you need someone to help you make a decision.
Here’s to a successful property investment journey.