Small Change Can Create Big Changes

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Recent interest rate rises have focused a lot of minds on loans and their repayment. You probably already know that making extra payments on a loan can save you money. But few people realise just how much. A relatively small change today can help you save large amounts in the future. Put another way, your small change today can create big changes in the future.

According to Canstar, the average new home loan for people buying an existing home is just a tick over $620,000.  There is a lot of regional variation around this figure. In Tasmania, the average new home loan is $436,000. In NSW it is $788,000, or 80% more than in Tassie.

The same source also tells us that the average standard variable mortgage rate on a loan is 4.27%.

If we plug these national figures into a standard mortgage repayment calculator, such as that provided by the Commonwealth Bank, and select a 30 year time frame, then the software tells us that the monthly repayment for a $620,000 loan is likely to be $3,058 per month. If the loan last for the full 30 years, then the total interest paid will be $480,625. Obviously, these numbers assume that the interest rate does not change. Here is how CBA’s calculator makes things look:

Now, let’s say you prefer round numbers, and you decide to round the monthly repayment up to $3100 per month, an extra $42 per month. Well, the total interest paid falls by $15,000 and you also shorten the period of the loan by nine months. Again, here is how the graph looks:

Now let’s imagine that you decide to give yourself a ‘buffer’ by making repayments today as if interest rates were actually 5.27%, not 4.27%. This increases your monthly repayment by $375 per month. In this case, if you keep this up (and again, assuming interest rates do not change) your total interest payment falls by $105,000 and you shorten the loan period by 5 years and nine months. Here is how the graph looks now:

Not everyone can afford a buffer of this size, of course. But if you can, then you can see just how much sense it makes financially. What’s more, if you set your loan repayments as if interest rates were 1% more than you are actually paying, then you have a buffer in case they do actually rise. You will already be paying the increased amount. At this stage, you may decide that you cannot afford to stay 1% ahead. But that is OK: every extra dollar you have repaid is a permanent reduction in debt and therefore in future interest.

Another way to think about this is that, when you have a home loan, making an extra repayment is the same as making an investment that pays the equivalent rate of return. So, if your home loan rate is 4.27%, then an extra repayment will effectively ‘earn’ you 4.27% on that money. What’s more, if this is a loan for the home you live in, that is effectively the after-tax rate of return. This is one reason why most people focus on repaying home loans whenever they get extra cash, for example from an inheritance or even some unexpected overtime. Reducing this debt is one of the best ‘investments’ you can make.

One of the things we love to do is help our clients best manage their cash flow. If you have a home loan, then letting us have a good look at your cash flow will probably help identify some extra cash that could be diverted to repaying your loan early. So, get in touch and let us take a good look at your financial situation. A small change today can have a large effect on the rest of your life.

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