Creative Finance Newsletter MAY 2010

How to reduce your home loan debt

We all want to pay off our home loans and own our homes outright, but it can feel like a huge undertaking.

This article looks at simple but effective ways to achieve this goal.

You can knock years off your mortgage by employing smart strategies including paying more than the minimum and making more frequent payments.

Here are a few of the more effective strategies.

Make extra repayments

Increasing how much you pay, particularly in the early years, can have massive long-term benefits. Many bank and lender websites have calculators that approximate the effects of changing your repayments. Plug in your loan and payment details to see what difference a change could make, or ask your lender to crunch the numbers for you.

For example let’s say you have a $400,000 variable loan, with a rate of 7.5%. The loan has twenty five years left to run at your present repayment levels - the minimum fortnightly repayment. Adding $100 per fortnight to the minimum fortnightly repayment would take over four years off the life of the loan and over $97,000 in interest off the loan.

Professional packages

Depending on the amount you’ve borrowed (or sometimes your salary or line of work), you may be eligible for a low-rate "professional package".

Although you typically have to pay an annual package fee these packages can be very worthwhile, especially as some of them offer interest rates of around 0.7% lower than standard rates.

Taking a $400,000 loan and using an example of 7.5% as a standard variable rate, here is the difference a professional package rate can have. The minimum monthly repayments would reduce from $2,950 per month to $2,775 per month, a saving of $175 per month. Paying this into your home loan would save over three and a half years and nearly $70,000 in payments.

There are also a few relationship benefits with these professional package loans. Whilst not the main reason for taking a package, these can be useful. Typical benefits include fee-free transaction or credit card accounts, discount insurance and financial advice.

Pay fortnightly

Another clever strategy to repay your mortgage more quickly is to divide the required payment by two and pay fortnightly.

The difference here is that rather than make 12 monthly mortgage payments a year, you end up paying the equivalent of roughly 13 which of course speeds up your repayments. So this is a subtle twist on the strategy of making extra repayments into your home loan.

Taking our example of a $400,000 loan and an interest rate of 6.8% with a 25 year term this strategy would take four years off the life of the loan.

Ditch the bells and whistles

Interest rates on basic mortgages are often lower than rates on standard (premium) and equity (line of credit) loans.

These premium products have bells and whistles such as redraws, payment holidays, interest only, an offset account, and the ability to split the loan to part-fixed, part-variable.

Do you really need these additional features or would the “no frills” loan be sufficient? The difference in interest rates can be up to 0.5%. On a $400,000 loan that’s a saving of $125 per month that can be an extra payment against the loan principal and saving two years and eight months from the life of the loan.

Shop around

There are hundreds of different loans on the market from a large range of home loan lenders. Their home loan products have widely different interest rates and features. Also, many of the lenders run special limited-time offers, or don’t market their products directly to the public.

By using the services of a mortgage broker, a borrower can secure the best and most cost-effective home loan for their specific needs.

Keep your other debts in check

There is no point focusing on putting all your money into the house while incurring credit card debt.

This is particularly important given that most other debts such as credit cards charge a much higher rate of interest than your home loan.

As a result if your credit card has got out of hand, it may be worthwhile considering consolidating your debt by rolling it into your mortgage.

However, while you will benefit from the lower interest rate, you should be mindful that what you are really doing is turning what should be short-term debt into long-term debt.

To offset this you should increase the home loan repayments – and of course, not build up the credit card debt again.

Summary

Paying off your home loan as quickly as possible is the dream of most borrowers. Through smart thinking there are many strategies that will help you achieve this end.

Balance transfer credit cards

Transferring your debt to a low-interest card may not be the magic fix it seems.

This article examines the five major traps of these balance transfer offers, and gives some advice on how to avoid them.

Credit cards companies commonly market low interest rates for debts transferred from other cards as a way to attract new customers.

Usually, the interest rate applying to the balance transfer ranges from 0% to 5%, for a period of four months up to as long as it takes you to repay the debt.

Switching to a low-interest balance transfer card can be a good way to get a handle on your debt, or to avoid making repayments for a specified time.

However, for the unsuspecting or undisciplined balance transfer cards can be a disaster. Card companies also use balance transfers to “reel people in” with tempting offers but then catch them out with terms and conditions that can create bigger interest bills than before.

There are five specific traps to transferring a balance to a new credit card.

1. The payment hierarchy con

When you make repayments, they’re firstly applied to the balance transfer amount.

This is the case even if it has a 0% interest rate or some time before the introductory period expires, and even if other purchases and cash advances are accumulating interest at much higher rates.

2. High interest on new transactions

After you transfer your debt to a low-interest card, any new transactions you make usually attract interest immediately at the standard rate, which is invariably much higher than the low introductory rate.

You may have no interest-free period with such transactions.

Here’s an example taken from the fine print of a major bank:

“You will not gain the benefit of the interest free period on credit purchases until the full balance (including any balance transfer and any other promotional amount) is paid by the statement due date each month.”

However not every provider treats new transactions in this way, so it’s worth shopping around.

3. Luring you into a bad deal

The balance transfer might simply be the hook that lures you into a card that’s otherwise poor value in terms of fees and standard interest rates. Many have standard annual interest rates close to 20% or even higher.

4. Handling fees

A fee may apply to transfer the balance. For example, according to one bank’s fine print there’s “a 1% Balance Transfer Handling Fee to a maximum of $50 that applies to each balance transferred”.

5. Double trouble

You might be tempted to keep spending on the old credit card, increasing your debt problems and requiring even bigger debt repayments for two cards and increasing your problems.

Consider cutting up the old card.

Do your research

As always the best way to avoid these traps and to use the balance strategy transfer to your advantage is to do your research.

Look at the various offers at the market and compare them closely. Make sure that you consider the:

  • balance transfer rate
  • normal interest rate
  • balance transfer handling fee
  • payment hierarchy rules
  • what happens to the interest free period for new transactions whilst the transferred balance remains on the card.
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