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When it comes to saving interest on your mortgage, there is no secret formula.
Glen McLeod is director of Edge Mortgages. It answers readers’ questions about home loans, whether you’re a newbie just entering the market or someone who already has a loan and wonders how best to handle it. If you have a question, email [email protected]
Q: We have acquaintances who have followed an aggressive policy to repay their mortgage. We don’t know them well enough to ask how exactly to do it, but it usually goes something like this: A fixed amount for the long term, a fixed amount for the medium term, and a fixed amount for one year. Long term fixed amounts are paid at the minimum repayment while the year fixed term is fixed and repaid at a rate such that the full amount will be repaid within the year.
Does this type of strategy really pay off faster? I can’t get the math to work.
A: Basically, anything that increases your efforts to pay off part of your loan faster should save you money in the long run.
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People sometimes separate an amount like this to focus and get rid of, as it helps them target their repayments and gives an extra sense of satisfaction when a small loan is paid off.
Loans are sometimes split as you describe to prevent the full amount from being lost just as interest rates peak.
McLeod says there’s no secret formula when it comes to saving interest on your mortgage. “The reality is that the way to save interest is to make extra payments whenever possible.”
He explains that your loan setup will depend on a number of factors, including how interest rates change, your income, how much you can afford to repay, and what products your lender offers.
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Banks, like any business, want to charge as much as they can. That’s what it means for your interest rates.
“Let’s start with interest rates. If the interest rate market is up, chances are when you fix your loan you’ll get a recommendation for a longer-term interest rate,” he said.
“It’s down to not wanting to do a number of different loan splits where one could break out at one year, two years and then three years. The reason for this is that each year is an opportunity for interest rates to rise, thereby increasing your payments.
But he says if interest rates go down, then a one-year rate might be better. “That being said, it’s important to discuss this with your advisor to make sure you don’t end up in a situation where you get a rate shock because the loan you have is so large that any increase would be detrimental to your service capacity. And in this case, it might be better to split the loan in half.
He says someone with a $500,000 home loan and a three-year interest rate of 5.39% on a 30-year term would have a monthly payment of $2,804.53.
“Let’s also say that your budget allows you to make payments of $3,000 a month for your mortgage. In this particular case, I would suggest that you use the full $3,000 for your payment each month. The extra $195.47 per month would mean that your loan term would decrease by four years and save $85,353.31 in interest if it continued for the full term of your loan.
He said some people will also pay off their loan faster by making lump sum payments on their loans. When interest rates rise, it is easier to do so without penalty.
“Indeed, if your interest rate was 5.39% for three fixed years and six months later the interest rate for your remaining time was approximately 6.5%, you may not have be no breakage fees. [That would] allow you to make a lump sum reduction that saves you interest and reduces the duration of your loan. My suggestion would be to continue with your higher mortgage payments even though you have reduced your loan balance. Every penny counts when trying to repay your loan.
He said some people might choose an offset or revolving credit facility.
“This could be very handy if you have savings that you are not going to use to reduce your loan balance. For example, if you had $100,000 in savings and a loan facility of $100,000. An account clearing could save you money, the idea here being that your $100,000 stays in the savings account and earns no interest.
“The $100,000 loan you took out bears no interest. In fact, any repayment you make on this loan would reduce the principle. Therefore, you save interest daily. The other thing to note is that when you earn interest on savings, you pay tax on the interest. When you’re earning interest at, say, 0.05% less tax and paying 5.39% interest, that’s a pretty easy decision. »