Paying off loans quicker than the loan term to save money
It might seem like a no-brainer: paying your loans off faster than the loan term can save you a substantial amount of money.
But many people are reluctant to sink more cash into their debts than they have to, which is understandable, considering the rising cost of living, and the seemingly simultaneous decrease in disposable income that we are all noticing in this economy.
One thing is simple: the more money you owe, the more interest you pay.
And over the lifetime of a substantial loan like a mortgage, this could mean you’ve paid for two houses, and only have one to show for it. But there are a few factors to consider that might provide good reasons for you to hold off on your debt-destroying crusade.
Paying out early
The obvious benefits of paying off your loans faster are improving both your debt-to-income ratio and your loan-to-value ratio, thereby reducing the risk potential lenders perceive you to be, and providing valuable equity in your property. You will also be able to enjoy a debt-free lifestyle substantially earlier than if you adhered to the initial payment terms of your loan.
You can pay your loan faster by increasing the payment amounts, or by making lump sum payments, but simply making more frequent payments can also work: take your monthly repayment figure, and divide it in two, and pay this figure every fortnight. It’s unlikely to affect your disposable income and your standard of living, but it could be a difference of thousands of dollars over the lifetime of your loan, for the simple reason that there are 26 fortnights in a year, and only 12 months.
Paying fortnightly instead of monthly means that you will be effectively making 13 monthly payments every year instead of 12, contributing several thousand dollars a year to your loan that you’ll barely even notice you’ve put in.
Pitfalls of paying out early
Extra monthly repayments on a mortgage might reduce the interest or the lifetime of the loan, but it might be a sounder economic manoeuvre to spend your extra money on improvements to your home to increase its value. You might work as hard as you can to pay out your mortgage earlier, and you might even cut years off the end of it, but it might not be worth it, if it significantly impacts on your standard of living.
There are also some nasty exit fees to consider. Hopefully, you haven’t been locked into a loan contract that will penalise you for all your hard work, by slapping you with a huge fee at the end of it. If the exit fees are great enough, you could potentially waste years of effort in frugality, when you could have been enjoying a more comfortable life with a higher disposable income.
It’s also unlikely that you’ll be able to make extra payments on fixed-rate home loans, which is a trade-off for protection during interest rate rises, and on loans where you are allowed make extra repayments there might be a limit on how much extra you can repay.
Alternatives to paying out early
Improvements to your home also add value to the property, and can reduce your financial liability. Spending money on renovations instead of putting it into your mortgage may mean an improvement in your loan-to-value ratio, by giving you more value—and equity—in the property that you can use to finance an investment, or negotiate a better loan rate with your bank (or one of their competitors). Although the amount you owe on the loan doesn’t change, the increase in the value of the property means that you may have more leverage to reduce the interest you’re paying, or to draw on a line of credit when you need one.
Drawing on your equity to finance an investment property is one instance where a bigger debt can be beneficial in the long run. As long as you have the serviceability, your investment property could provide you with income in your retirement when the life of the loan has ended. It might make sense to speed up paying off the mortgage on the property you live in, but you might be doing yourself out of the tax benefits associated with mortgages on investment properties if you choose to invest more money in these loans. The interest on your investment property loan is tax deductible, and therefore less of a financial burden, and less of a priority that that of your home loan.
Many home loans now offer an offset facility, which can provide a good alternative to making extra loan repayments, or saving money in a high-interest account. With an offset account, you can access your money as you need to, but the loan amount is theoretically reduced by any amount you have saved in the offset account, and the interest is calculated on this balance. This way you can reap the benefits of a reduced interest rate by sinking money into your savings when you have it, without the risk of being caught out when a financial emergency happens.
Regardless of which path you decide to take, good financial advice is an essential expenditure. Take the time to speak to a professional financial advisor who can show the best way to invest your disposable income, and get you the best advantage from your loans.
Small Personal Loan
Up to 20% Establishment Fee
+ monthly fee up to 4%
Jacaranda Finance does not charge an annual interest rate on SACC loans. These small amount loans incur 'fees' instead of interest. The maximum comparison rate on our loans between $300 and $2000 is 199.43%.WARNING: This comparison rate is true only for the examples given and may not include all fees and charges. Different terms, fees or other loan amounts might result in a different comparison rate
Loan Amount of $1,000 over 6 months repayable weekly (25 weekly repayments). $1,000 (Principal Amount) + $200 (20% Establishment Fee) + $240 (fees based on 4% per month over 25 weeks) = $1,440 total repayable in 25 weekly installments of $57.60.
Loan Amount of $1,000 over 12 months repayable weekly (50 weekly repayments). $1,000 (Principal Amount) + $200 (20% Establishment Fee) + $480 (fees based on 4% per month over 50 weeks) = $1,680 total repayable in 50 weekly installments of $33.60.
Medium Personal Loan
Annual Percentage Rate (APR) starts at 20.56%
Comparison Rate is 20.56% per annum.
This comparison rate is based on a medium amount credit contract of $2,500 repaid over 2 years with a $400 establishment fee and APR of 20.56%.WARNING: This comparison rate is true only for the examples given and may not include all fees and charges. Different terms, fees or other loan amounts might result in a different comparison rate
Loan Amount of $3,000 over 18 months repayable weekly (78 weekly repayments). $3,000 (Principle Amount) + $400 (Establishment Fee) + $555.83 (reducing interest*) = $3955.83 total repayable over 18 months with weekly installments of $50.71.
Loan Amount of $4,500 over 24 months repayable weekly (104 weekly repayments). $4,500 (Principle Amount) + $400 (Establishment Fee) + $1081.85 (reducing interest*) = $5981.85 total repayable over 24 months with weekly installments of $57.51
Large Personal Loan
Annual Percentage Rate (APR) is 12%
Comparison rate is 19.88% per annum.
Loan Amount of $5,000 over 18 months repayable weekly (78 weekly repayments). $5,000 (Principle Amount) + $1831.16 (Interest) = $6831.16 total repayable over 18 months with weekly installments of $87.57.
Loan Amount of $10,000 over 24 months repayable weekly (104 weekly repayments). $10,000 (Principle Amount) + $5041.72 (Interest) = $15041.72 total repayable over 24 months with weekly installments of $144.63.