Many homeowners and property investors are delighting in the decision of the Reserve Bank of Australia to start slashing interest rates, as the global economy once again hits a rough patch and economic uncertainty grips much of the developed world.
BY ROLF SCHAEFER
As the banks pass on these cuts (at their discretion of course), most mortgage holders jump at the chance to save money in the short term, with the promise of an immediate reduction in their monthly repayments. And that’s fine.
But what if I told you there was a way you could save a lot more by taking a longer-term perspective on your loan? What if I told you that instead of saving a few hundred dollars over the course of a year, a 0.5 per cent fall in interest rates could save you thousands over the life of your mortgage?
Interested? Then read on…
When a fortnight means more than a month
In the past, I’ve explained the financial benefit of increasing the frequency of your mortgage repayments from monthly to fortnightly. By paying half of your monthly obligation to the banks each fortnight, you are in effect making 13 monthly repayments instead of 12 over the course of a year.
Think about it this way – if your monthly repayment was, say, $2300 and you opted to pay half this amount – or $1150 – per fortnight, you would repay a total of $29,900 over 12 months as opposed to $27,600 if you made the minimum monthly repayment. In other words, you would make the equivalent of one extra repayment and thereby reduce the term of your loan as well as the interest payable.
But wait, there’s more
Now consider the savings you could enjoy on your mortgage if you not only opted to make fortnightly repayments, but you also chose to maintain the same level of repayment even though interest rates had come down.
Taking the above example, if you continue to pay $1150 per fortnight on your mortgage ($2300 per month), even though the bank decides to drop their rates and reduce your repayments to say $1100 per fortnight ($2200 per month), you’re now shaving an additional $1300 off your home loan debt every year.
Now for the best bit
If these annual savings aren’t incentive enough to take this advice on board and keep up your repayments even as interest rates are on the way down, then let me explain it like this…
Assume you borrow $500,000 over 25 years, at an interest rate of seven per cent. By making your minimum monthly repayments over the life of your loan, you’ll end up shelling out a total of $1,060,147.
But when you choose to pay just $60 a month more, you’ll shave a substantial $28,917 off your entire mortgage, reducing your total outlay to $1,031,230.
And when you up the ante even higher, paying an extra $200 per month than is required by your lender, your total 25-year debt is now in six figure territory at around $975,231.
This represents a massive saving of $84,842 and three years off the life of your loan!
Double the benefits
Taking a big picture view of your property-related debt, aiming to save money on your mortgage over the long run by using these types of financial strategies has a couple of obvious benefits, particularly for property investors.
Apart from saving money, there’s the fact that you’re building up an additional cash flow buffer that you can call upon should your investment income drop off for any reason.
A cash flow buffer will allow you to maintain your mortgage repayments if and when interest rates rise again, meaning that the extra time and savings you buy yourself by paying more than you have to when repayments fall will continue to pay off.
Then of course there’s the fact that you are, in fact, manufacturing equity in your property portfolio by paying more off your mortgages and thereby reducing your debt.
This is a great strategy when housing markets fall flat as they have in recent times, because it means you can still continue to grow your portfolio’s equity, even if values are stagnating.
Most experts are predicting that it’ll be some time yet before we see another property boom that sends house prices soaring as they did last decade. As such, investors would be wise to take advantage of the current economic climate and use the resulting interest rate cuts to generate equity and cash flow buffers that they might not otherwise gain through natural market movement.
Now’s the time to take a ‘steady as she goes’ approach to your property portfolio and related financial strategy. Take stock, get ahead of the game and set yourself up for the next rainy day, because there’s always bound to be one just around the corner.
And remember – property investing is first and foremost about accumulating wealth. Sure, you’ll have to do it the expensive way initially… by borrowing money to make your millions, but that is a far better option than doing it the really expensive way – by taking forever to pay the debt back!
Rolf Schaefer has a wealth of knowledge about property investment, property finance and complex structures. His ‘can do’ approach has helped many property investors through the finance maze. Rolf has rated among the top Australian Mortgage Brokers for the past five years. For more information about Rolf visit www.metropolefinance.com.au.