When it comes to home-ownership, for most of us this is achieved through saving a deposit and funding the balance via a home loan from a lending institution (e.g. bank, building society or credit union).
Importantly, while the loan can help us with entering the housing market, it’s vital to remember that this will most likely be the largest, and most time/cashflow-consuming, debt that we pay off in our lifetime.
According to Australian Bureau of Statistics (ABS) data analysed by CommSec*, in December 2019, for an owner-occupier, the average new home loan to buy an existing dwelling was $497,900 in Australia.
Here is a further breakdown on this with regards to individual states and territories:
- $517,900 in Victoria (VIC)
- $419,800 in Queensland (QLD)
- $358,200 in South Australia (SA)
- $409,900 in Western Australia (WA)
- $621,500 in New South Wales (NSW)
- $379,100 in The Northern Territory (NT)
- $490,800 in The Australian Capital Territory (ACT)
Importantly, these figures only paint part of the overall picture, for example, there is not only the principal to consider, but also the interest an owner-occupier can pay over the life of the loan.
To highlight this fact, here is a simplistic example.
An owner-occupier takes out a new $X principal and interest home loan to buy an existing dwelling. They opt for monthly repayments and pay the minimum repayment of $X per month. The comparison rate on the loan is 3.17%^ and the loan term is 30 years. At the end of the loan term, they could pay a total of $X.
^According to recent Reserve Bank of Australia data (RBA), 3.17% was the average lending rate charged by financial institutions for housing credit on new owner-occupied home loans (on a principal and interest repayment basis) that were funded in December 2019. Please note: In August 2020, the average lending rate was 2.64%.
See the below table for the results.
|Examples: Home loan repayment*|
|Area||Home loan||Monthly repayment||Interest paid||Principal & interest paid|
*Please note: These are simplistic examples—they don’t, for example, take into account the effect of potential interest rate movements over time.
When paying off your home loan, it’s important to consider an ongoing proactive approach. By doing so, you can reduce the amount of interest that you pay, and decrease the life of the loan. In turn, you can free up cash flow sooner and direct it elsewhere, such as saving and investing for the future.
In terms of taking an ongoing proactive approach, here are several considerations, which may be used individually or in conjunction with each other:
1. Make weekly or fortnightly repayments instead of monthly.
When looking at fortnightly repayments as an example, if you make half of the monthly repayment amount every two weeks instead of once a month, you end up paying the equivalent of one extra monthly repayment per year. This is due to the fact that there are twenty-six fortnights in a year, not twenty-four.
In addition, with interest on the loan generally calculated daily, by making more frequent repayments than monthly, you can further reduce the interest payable over the life of the loan.
2. Consider an offset account.
An offset account is a savings or transaction account linked to the loan.
The money in this account earns no interest, but you will also pay no interest on the corresponding amount of the loan. For example, suppose you have $50,000 in an offset account linked to the $500,000 loan. In that case, you will only pay interest on $450,000. Lastly, the money is available to withdraw at any time.
3. Pay more than the minimum repayment and/or use lump sums to make additional repayments.
If you have surplus income, or have received a windfall/inheritance, consider paying more than the minimum repayment or using the lump sums to make additional repayments. In both instances, you are accelerating the rate of which the loan is paid off—saving you interest and reducing the life of the loan.
4. Maintain your repayments if interest rates fall.
Despite the current low-interest-rate environment, this point is still an important consideration. Interest rates can rise and fall over time (and over a 30-year loan term). For example, see below regarding the RBA, and their past interest rate decisions:
- October 2020, 0.25% cash rate target
- October 2015, 2.00% cash rate target
- October 2010, 4.50% cash rate target
- October 2005, 4.75% cash rate target
- October 2000, 6.25% cash rate target
- October 1995, 7.50% cash rate target
- October 1990, 13.00% cash rate target
Please note: In the RBA’s recent November monetary policy meeting, the RBA Board decided upon a reduction in the cash rate target from 0.25% to 0.10%.
5. Consider refinancing if you find a more appropriate home loan.
In terms of refinancing, according to a recently released interim report# by the Australian Competition & Consumer Commission (ACCC), customers with new loans continue, on average, to pay lower interest rates than customers with existing loans. The ACCC notes the following with regards to customers with existing loans:
- Ask the lender for a better rate.
- Switch to a cheaper product at the same lender.
- Switch lenders to take up the best available offers.
For many of us, our home will most likely be the largest asset that we hold. However, the loan that we take out to purchase it will also most likely be the largest debt that we pay off in our lifetime. Therefore, when it comes to paying off your home loan, it’s important to consider taking an ongoing proactive approach.
Importantly, prior to taking action on any of the above considerations, please consider seeking advice from a professional adviser to understand their appropriateness to your financial situation, goals and objectives.
After reading this article, you may also find the following of interest:
- Debt management
- Home loan offset accounts
- Refinancing your home checklist
- Tips for paying off your home loan sooner
- Monetary policy, cash rates and interest rates
If you have any questions regarding this article, please contact us.
*CommSec. (2020). Economic Insights. Average mortgage hits $500,000. Economics, February 11 2020.
^Australian Government, RBA. (2020). Statistical tables: Interest rates, housing lending rates.
#Australian Government, ACCC. (2020). Home loan price inquiry: Interim report. March 2020.