A little can go a long way. Now that you have a mortgage it’s important to understand a little about compound interest. When you save money you earn interest, not only on the original amount but also on the interest that you’ve earned. What few understand is that this “interest on interest” grows exponentially.
It’s the same, but turned upside down, with the mortgage. The more you can pay off, the less interest you will be charged and, just as each little payment on your savings adds to the “interest on interest” so each little payment subtracts to the interest that the bank can charge.
With that in mind, there are few things that you can do get to get rid of the mortgage sooner. And keep in mind that a little will potentially make a huge difference in the end.
Pay more each month (perhaps only one coffee a day).
That’s pretty obvious. Over the lifespan of a mortgage, the savings can be significant. Pay an extra $300 per month (that’s about a daily cup of coffee for 2 people) and you’ll decrease your $500,000 mortgage from 30 years to 25 years and you’ll save over $77,000. What I’m saying is that that extra cup of coffee every day for two people costs around that much. You’re welcome to confirm these figures at https://sorted.org.nz, but trust me, compound interest is mind-boggling. Think again whether you should not sacrifice that second cup of take-away coffee.
You can also find other ways of adding to the repayments. Consider taking in a flatmate, or better even, purchase a property that has a separate unit.
Be flexible
Consider negotiating the entire mortgage at a one fixed rate, spit it into smaller mortgages with various fixed rates, or even a portion of it at a variable interest rate. That makes your loan structure more flexible, especially if your needs change over time.
Pay fortnightly, not monthly
That’s again tied to the magic of compound interest. Without feeling it, you’re actually paying one additional fortnightly payment a year (the year has 12 months, but 26, not 24 fortnights). That could cut your $500,000 mortgage by around 4 years. In effect, you’re just paying a bit more. This is calculated at an interest rate of 4%. Again, you can verify these figures at https://sorted.org.nz.
Use your credit card
Banks offer an interest-free period for purchases on your credit card. As long as the repayment is made within a certain period (usually a few weeks) you don’t pay interest. Why not structure your credit card to use that interest-free portion to pay the mortgage. That way, every month (or fortnight if you follow our previous advice), you get a portion of your repayments interest-free.
Play a lump sum when you can
If you come into some money, be that an inheritance, an asset sale or you come into some money in another way, consider putting that towards your mortgage.
Some fixed-term mortgages allow a penalty-free repayment of a certain percentage (usually around 5%). More to the second point above, if you’ve structured the mortgage with a portion on a variable interest rate then you can make repayments without penalties.
Lump-sum payments have two benefits: they reduce the principal about and you’re don’t have to not paying the interest portion of your lump sum, and your principal reduces, so you’re paying less interest in the future or, if you keep the repayments the same, you’re paying the loan off faster and you’re paying less overall.
Don’t be tempted to reduce repayments
When interest rates drop it can be tempting to reduce your mortgage repayments. Our advice is to keep the repayments the same. A drop in interest rates has the same effect as increasing payments and we’ve already seen how a small, nearly insignificant amount, can make a huge difference in the overall savings. Stick to your repayments and you’ll be rewarded at the end.
On our $500,000 mortgage, a drop in the interest rate of 0.5% will save $53,000 over 30 years, or reduce the term of the mortgage by 3 years.
Conclusion
Paying off a mortgage can seem daunting. You’re asked to commit to significant payments for 30 years. By increasing monthly payments you save significantly more that the total of that at the end of the term. Negotiating good interest rates, making lump-sum payments, or adding just that little bit in your regular (monthly or preferably fortnightly) payments will make a dent into that commitment. Some of those dents can be quite large. Our advice is to see every small reduction in interest payments as a win deserving of a fist-pump.
Talk to us for advice on your mortgage.