Easy, start with a shorter loan term
I’ve written extensively on various methods of paying your home loan off quicker, saving yourself tens of thousands dollars and shortening your loan term. The incentive is huge given the large amounts of money you can save on loan interest.
The high cost of your home loan is not just the interest rate but the time it takes to pay the loan off. Mostly we concentrate on finding the lowest interest rate for a home loan and don’t think about the term of the loan. We take it for granted.
Interest rate vs term-part 1
The question is always’ what’s the lowest interest rate, what’s the lowest interest rate’. The question never asked is ‘what is the shortest term that I can afford on this home loan’.
We accept the standard term 30 year home loan without question. At times, there’s good reason to do this. It enables people to borrow more which is required to afford the home they want to buy. But not always.
Once a 30 year loan term is in place, we discuss with borrowers various methods, tricks and tips they can use to reduce the time it takes to repay their loan in full. The incentive is to pay the loan off quicker and save money on avoidable interest.
The obvious alternative
The obvious alternative to a 30 year term where affordable is applying for a loan with a shorter term from the get go. This is possible where a borrower’s income is sufficient to enable repayment of the loan over a shorter term without financial hardship.
Reducing the loan term is by 2,3, 4 or 5 years will make a huge difference to the amount of avoidable interest paid to the bank. Doing this right from the beginning means borrowers simply need to make minimum loan repayments to achieve significant savings. They will achieve the same results as somebody with a longer loan who needs to increase their minimum repayment to achieve the same result.
$86,855 saved for ten bucks a day!
Consider a $400,000 loan with an interest rate of 4.5%. Over 30 years total interest paid is $329,627. Start with a shorter loan term and see what you save;
- 28 years save $25,398
- 27 years save $37,925
- 26 years save $50,336
- 25 years save $62,628
- 23 years save $86,855
Yes, your minimum loan repayments will be higher with a 23 year loan term rather than 30. But, surprisingly the difference is not large. A mere $10/day, will save you $86,855 of your hard earned cash. Not a bad return I would say.
Interest rate vs term-part 2
Next time you are overly fixated on finding the lowest interest rate rather than reducing your loan term consider this; In our example above of a $400,000 home loan, a person with a 30 year term would require an interest rate of 3.70% to pay the same total interest to the bank as a person with a 25 year loan at 4.5%. Finding that 0.8% interest rate saving maybe harder than shortening your loan term.
The take way here; the next time you apply for a home loan, either to buy a property or refinance an existing home loan consider the loan term carefully. Get you broker( me hopefully) to calculate your repayments on various loan terms. See what fits in your budget. Assuming your borrowing capacity is sufficient with your lender of choice, opt for the shortest term you can.
You’ll be laughing all the way to the bank, own your home years earlier and save tens of thousands of dollars. Not a bad outcome.