Repay Your Way to Financial Freedom
Author: Vidhu Bajaj Source: HashChing
As 2016 is well under way, most of you have probably set your financial goals for the year ahead. BUT, how many of you have stopped and analysed your home loan?
While your home loan might be the best fit for your circumstances, smart planning can help you gain financial freedom faster. By giving thought on how you service your loan, you could be paying off your loan quicker – which also means you will pay much less interest over the life of your loan!
Repay Your Way to Financial Freedom…
If you can make extra repayments on your home loan, you can shave years off the term of your – which means you will save on the amount of interest you pay. That is, the more principal you can pay off by putting extra funds into your loan, the more your repayment will go towards paying off the loan rather than being dedicated to servicing the interest.
Many banks will allow you to make additional repayments on your loan at no extra cost – and you don’t necessarily have to wait until you save enough for a lump sum payment. By simply changing your repayment frequency from monthly to fortnightly you will already be paying off your loan faster – as you will be making 13 full repayments in a year as opposed to 12!
A repayment calculator is a simple tool that helps make your home loan decisions easier. You can calculate your repayment amount by simply putting in the desired loan amount, term of the loan and the interest rate. What’s more – see how much time and money you can save if you choose to make additional repayments on your loan with an additional repayment calculator.
If You Need the Extra Money…
A valid concern of many mortgage holders is that if they make additional repayments on their loan, their savings are impacted and that they won’t have any reserve funds if something unexpected occurs.
The good news is, many lenders offer redraw facilities on additional repayments made, or they give you the option of an offset account linked to your loan – which allows you to withdraw any additional money (extra repayments) as required.
Both a redraw facility and offset account help you pay off your loan faster, but they are two different features and it is important to understand how they are different…
A redraw facility allows a borrower to redraw the additional repayments made against the home loan. For example:
Jessica has a 25 year term home loan of $300,000, with an interest rate of 5.5%. Her monthly repayments are $800, but Jessica elects to pay an extra $100 a month off her loan – meaning her additional repayments total $1,200 over the year. These addition funds are used as an emergency fund – where Jessica can draw from if needed. If Jessica continues to make an extra payment of $100 each month, and does not use her redraw facility, she will save $29,917 and 2 years and 6 months off the life of her loan.
Remember, different banks provide different offers. Many lenders offer a redraw facility for free but some may charge up to $50 per redraw. There could also be a limit on the number of free redraws and the amount you can redraw in a year, so make sure you compare different lenders and loan products so you can choose the best option to meet your circumstances.
An offset account is a savings account linked to your home loan. Any amount you keep in this account is offset against your loan amount, reducing the interest paid on a daily basis. Thus, the more money in your offset account, the less interest you pay overall. For example:
John has a 25 year term home loan for $300,000 with an interest rate of 5.5%. He opened an offset account linked to his home loan. John received $10,000 from his parents as gift and deposited it in his offset account. If John doesn’t withdraw this amount, he will save $27,634 and 1 year 3 months on his loan.
The key to fully utilizing this feature is to keeping a good amount of money in your offset account. Consider moving all of your savings into your offset account, or ask for your salary to be directly paid into your offset account. This way, you can maintain a high balance for the maximum number of days.
Which Option is the Right Option?
Though the function of a redrawn facility and an offset account seems the same, the choice on which is right for you depends on your financial condition and goals.
An offset account is suitable if you have a stable income and can maintain a substantial balance in the account. On the other hand, if you think you have extra money now and would rather build up a fund for the future, a redraw facility could be more suitable for you.
Don’t forget to consider the purpose of your savings. Using the amount redrawn from an investment loan for non-investment (or personal) purposes means the interest on that amount is no longer tax deductible. You can use the money you withdraw from an investment loan offset account for non-investment purposes without losing the tax benefit; but we recommend you consult an expert before doing this.
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Published: 23 February, 2016.