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Minimise your interest and maximise your equity: how to get ahead financially
We all know that additional loan repayments bring down the length and interest cost of your loan but how do we manage this and what kind of loan will work for you?
There’s no one way to manage your loan – what works for you won’t work for someone else – but it’s important to be actively involved in the process as this can have a major impact on the length and cost of your loan.
One way to think about all this is to think about what type of borrower you are. Whether you’re taking out a loan for personal or business reasons, understanding how different types of borrowers manage their loans is essential to getting ahead financially.
What type of borrower are you?
When it comes to managing a loan, borrowers typically adhere to one of three different repayment strategies depending on the type of loan taken out.
With the option for fixed rate, variable rate and split home loans (which have a component of both fixed and variable rates), borrowers can opt for various repayment strategies. It’s important to understand the nuances between the standard three types of loans, so that you can make the best loan choice for your financial situation. The key here is to understand how your repayment approach can affect your long-term financial goals.
Type 1: Financial Security
Do you want the security of knowing you have consistent, predictable payments with no extra surprises or fees? If so, a fixed-rate loan may work for you. For the fixed rate term, you will have a steady minimum monthly repayment and rest assured that you have a regular repayment schedule to stick to. Generally, fixed rate home loans have some restrictions, such as the inability to pay-in more than the minimum amount each month, however some fixed-rate loans may even let you make those extra repayments when things are going well. We find that people who opt for a fixed rate loan are either primarily focused on the financial security aspect or simply accessing the lowest possible rate (on those occasions where fixed rate interest rates are lower than variable). Active loan management is usually a distant second or third consideration.
Type 2: Financial Engagement
Do you like to manage your finances? Are you in a position to make more or larger repayments? If you are able to be more actively involved in your repayments then variable-rate loans are a great option. Most variable rate home loans allow the flexibility of making extra or larger repayments, which will help to reduce the interest charged over the life of the loan, and changing interest rates may work in your favour. Our observations are that many people end up with a variable rate loan as effectively the default option, but there is a greater portion of borrowers that do become actively involved by paying more than the minimum that you see with Type 1, given the added flexibility of these loans.
Type 3: Financial Drive
Are you determined to get the most out of your money and committed enough to work towards that goal? Then a split-rate loan may be suitable for you. By taking advantage of opportunities like fixed-rate periods and low-interest periods, split loan borrowers are able to significantly reduce the amount of interest they pay over the life of their loan. Anecdotally, we find that borrowers that seek out this option are prone to be highly involved in their home loan. They have assessed market conditions and elected to choose a split loan which provides a buffer from variable rate changes (based on the fixed component of the loan) while also affording maximum flexibility in terms of additional repayments and redraw/offset interest options.
Brokers for borrowers
Unsure about which loan type suits you? Or looking to try a different type of loan? It’s all good. Brokers are required by law to work to find you a loan that suits your needs. Through a series of discussions, they’ll make sure to put you into a suitable loan product based on your financial situation and the goals you’ve expressed in those conversations.
Then, if your needs or situation changes, brokers can assess whether your existing loan is still suitable or select a new loan option with features that are more suited to the new you.
No matter what loan you take, no matter how great a loan product you’ve selected, if you don’t actively engage with the loan in a way that takes advantage of its features, then you’re not going to get the best out of that loan and you’re likely to pay more interest over the life of the loan than someone who does.
Those of us in a position to reduce the amount of interest paid over the course of the loan are going to want to. But life changes, economic conditions fluctuate and our financial situation evolves – these are all factors that need to be taken into account not just when we select a loan product, but throughout the life of the loan.
This may seem hard, but even just making extra repayments when you can is a big deal.
Let’s say you take a $500,000 loan over 25 years. With interest at 6.19% p.a. And repayments of $3,280 per month – that’s a total of $483,948 in interest over the life of the loan.
Even only $50 extra monthly repayment over the life of the loan will save $19,816 and 10 months of repayments. An extra $300 saves $97,070 and 4 years and 4 months of repayments.
So starting with a product that makes the most of your borrower type, and then being proactive with your repayments, is going to make a big difference to how you get ahead financially.
How to Get Ahead
Talking to your mortgage broker or financial advisor can really help get you started but ultimately the decision is yours. And so is the decision to keep being financially engaged through the life of your loan. It pays to remember that home loans are not ‘set and forget’. You have to be proactive. What suits you at the start may or may not suit you as the loan progresses.