Home Loan Savings
Wednesday 05 June 19
Do you that your home loan can help you save money? It can do that in a variety of ways. Let me explain.
It does cost money to have a loan. It’s the price for the use of someone else’s money. But that’s well worthwhile when it makes the impossible achievable. How long would it take to save enough cash to buy a house, starting from high school? A few lifetimes, I would imagine.
That’s understood. But if s loan costs money, how can you use it to save money?
Firstly, by paying less money for it. Often there is little control over the amount of money that’s coming in. And for those that do have the option, it’s a trade-off. Do you take that overtime and then have little time for the really important things in life? A better approach might be to reduce the amount spent. A good place to start is with the home loan. Take, for example, a person with a loan of $400,000. Paying 1% too much on that loan amounts to $4,000 per year. If that also means that because of cash flow limitations that you have to take longer to pay off the loan, then the cost is compounded. We are talking about potential savings of something on the order of $85,000 for that loan.* Even more if the loan was larger. That’s serious savings.
So, let’s say we get a super low interest rate. How else can you save money?
To open up a wide vista of opportunities, let’s think about what we are doing. Essentially we are saving money by not having to pay money. The lower interest rate did that for us. A number of other saving strategies do that by reducing the amount owing from what it otherwise would be. The simplest is by simply paying a little more than what you have to. This makes a huge difference near the start of a loan when the bulk of the payment is interest. Keep in mind that a standard loan repayment includes principal and interest. The interest is basically the interest rate for the period multiplied by the amount owing. That’s the price you are paying for the loan, and it’s money that’s down the drain. You will never see it again unless you are a shareholder in the bank! But all of the rest of the payment is principal. That’s what’s reducing the amount owing. When the amount owing is large, as it is at the start of the loan, most of your payment is interest. Money down the drain.
Let’s look at our $400,000 loan example, and let’s say it’s a 30 yr. loan with 4% interest. The monthly payment is $1,910 but only $576 of that is reducing the amount owing. So, what happens if you increase your repayment by that amount? The monthly repayment is now $2,486, which you keep at that level through the life of the loan, and you now pay off your loan in 19 yrs. 3 months, instead of 30 years. You save $113,299. That’s not junk change!
That gives us a good start on home loan savings, but to learn more, read our article on offset accounts.
*For a $400,000 30 yr. principal and interest loan, the total repayments with 5% interest are $85,545 greater than if it was 4%.