When it comes to household finance and lending, a home loan is likely to be one of your biggest debts (and monthly commitments) during your working life. So, what do you need to do to make sure you’re not paying any more than you need to on your mortgage?
Whether you’re borrowing to invest in shares or property, choosing the right loan type is the first step. And there are plenty of home loan options on offer from traditional and non-traditional lenders alike. The second step is to consider your repayment options, of which there are generally two to choose from:
So, which repayment type is going to be the best for you and keep more money in your pocket?
Some say there’s never been a better time to borrow money with Australian mortgage rates at an all-time low.
But decision fatigue is real among home buyers right across Australia. Because no sooner have you found your dream property (after months of searching), you then have to trawl through the loans on offer to find the one that’s right for you.
We’d like to help take some of the decision-making burden away and give you key insights into the repayment options available to you.
With a crackdown by the Australian Prudential Regulation Authority (APRA) in recent years, the loan repayment option you choose could mean a substantial difference to the quoted interest rate on your loan. The APRA decision in March 2017 was a directive to banks to restrict interest only facilities to a maximum of 30% of overall new lending. The common way that banks meet these directives is to put a higher interest rate on the product being restricted.
This means that you could save thousands on your mortgage just by choosing the right repayment type.
Principal and interest (P&I) is the most common type of repayment chosen by personal borrowers and is one that suits APRAs expectations for the Australian lending market. The monthly repayment on these loans includes both the interest charged for the preceding month and also a portion of the principal value you borrowed. This means that over time, your loan balance reduces and is fully repaid at the end of the loan term.
With interest only loans, you are only required to pay the interest charged on your loan balance each month. These loans have long been the domain of property investors, so they can maximise the interest on their loan (and subsequent deductions) for their investment property. In recent years, there has also been a shift to owner occupiers using these types of loans as a way of reducing their financial commitments. There is a much greater reliance on capital growth to build equity in a property which makes this a riskier type of lending. The interest only period is traditionally set at 5 years, and then P&I repayments will commence unless your bank agrees to an extension.
If you borrow $500,000 today at 5% over 30 years and nominate an initial interest only period of 5 years – you will pay interest on the full amount for that period and still owe $500,000 in 5 years’ time. With a P&I arrangement, you will have reduced your loan balance by over $50,000 in that time and improved your equity position outside of any capital growth.
In dollar figures – this means an extra $35,000 in interest over the loan term when choosing interest only repayments over P&I.
What Home Loan Repayment Strategy Is Right For Me?
If you’re keen to be debt free, paying off your loans is likely to be a priority for you and this decision may look clear cut in dollar terms. But your repayment option shouldn’t be decided in isolation from your current financial situation and future goals. There are several aspects to consider when investing in property no matter if it’s your principal place of residence, or an investment.
Here at RJS Wealth Management, we believe everything is interconnected, and the best way for you to reach your lifestyle potential is with a personal and considered approach when developing a strategy for your financial future.
We stand by what we say, and we’d love to make a difference in your life.
So invite us along on your financial journey, you will be amazed how far our expert guidance can take you.
Now that you’re on your way to reviewing your mortgage, don’t forget to ask your specialist if your greatest asset (your income) is properly protected? Find out more in our Income Protection Insurance: Protecting Your Most Important Asset article.
This blog has been prepared by RJS Wealth Management Pty. Ltd. ABN 24 156 207 126. RJS Wealth Management Pty. Ltd. is a Corporate Authorised Representative (No. 438158) of Modoras Pty. Ltd. ABN 86 068 034 908 an Australian Financial Services and Credit Licensee (Number 233209). The information and opinions contained in this blog is general information only and is not intended to represent specific personal advice (Accounting, taxation, financial, insurance or credit). No individuals personal circumstances have been taken into consideration for the preparation of this material. Any individual making a decision to buy, sell or hold any particular financial product should make their own assessment taking into account their own particular circumstances. The information and opinions herein do not constitute any recommendation to purchase, sell or hold any particular financial product. Modoras Pty Ltd recommends that no financial product or financial service be acquired or disposed of or financial strategy adopted without you first obtaining professional personal financial advice suitable and appropriate to your own personal needs, objectives, goals and circumstances. Information, forecasts and opinions contained in this blog can change without notice. Modoras Pty. Ltd. does not guarantee the accuracy of the information at any particular time. Although care has been exercised in compiling the information contained within, Modoras Pty. Ltd. does not warrant that the articles within are free from errors, inaccuracies or omissions. To the extent permissible by law, neither Modoras Pty. Ltd. nor its employees, representatives or agents (including associated and affiliated companies) accept liability for loss or damages incurred as a result of a person acting in reliance of this publication.