A mortgage can be a virtually watertight mechanism to grow your wealth. Think about it: you are (hopefully quickly) paying down an asset that’s (hopefully and preferably quickly) going up in value.
Or it can be like a leaky bucket with much of your hard-earned money running out of it and into the lender’s profit pool.
There are three main features that make the difference. And these are where you should start your all-important product choice.
Mortgage must-have No.1: The ability to make extra repayments
A mortgage is typically for 25 or 30 years… and the mortgage provider would dearly like you to stay that long because then you’ll pay the full whack of interest. On the average loan amount as listed by the ABS, (nearly) $400,000, it’s at an interest rate of 6.5% that the interest paid is double the price of your house. Yes, double.
But if you can instead pay even a little extra each month, it will save you a packet in the long run and bring your debt-freedom date happily forward. For example, just $100 extra a month – or roughly $3 a day – will save you more than $40,000 and cut two years off your loan term.
An additional $200 a month saves $72,000 and four years, while $500 nets you a bonus $141,000… and nine years of the life of the loan.
Bear in mind that if you opt to fix your interest rate, it is not always possible to make overpayments. That’s another reason that I advocate only fixing half of your loan and only for a maximum of three years (the other reason is pure safety – you are betting against interest rate experts about their future direction).
Basic home loans might not let you pay any extra either.
A final note: The ability to set up direct debits of a higher than necessary repayment is also great – when it comes to money, automate to remove the ability to prevaricate!
Mortgage must-have No. 2: The cheapest rate so those repayments count the most
Going back to our leaky bucket, an uncompetitive interest rate is often the main cause of the holes.
Let’s say you have two loan options: one from a big bank and another from a smaller or lesser known lender. The big bank’s rate will quite often be more than 1 percentage point higher than the smaller outfit. These outfits are where you find many of the home loan bargains, dominating the top 10 mortgages.
“One percentage point is not much though,” you may say. However, when you apply it to a number as big as a home loan, it’s huge. In fact on our $400,000 model mortgage, at current rates the difference is ultimately $73,000 in interest.
In other words, it’s virtually an average annual wage that you’re letting flow out of your pocket and straight to the bank.
(And if today you’re signed up to such a raw deal, don’t forget exit fees have been banned since 2011 and you are free to move. The only exception is if you’ve taken a punt on a fixed rate, in which case you’re hooked in for that term.)
The very cheapest mortgage deals are available if you have a deposit or equity of 30% or even 20%. In any case, your interest rate should start with a “3”.
If you shop around for just one thing in your financial life, it should be your mortgage.
Mortgage must-have No.3: An offset account
This magic little Aussie invention lets you use every dollar twice… for its purpose and to dramatically reduce your mortgage interest. It’s akin to a debt-busting secret weapon.
But let’s back up. An offset account is simply a saving account that runs alongside your home loan. Every cent you put in it is ‘offset’ against your loan balance – so if you have our average $400,000 loan and $10,000 sitting in an offset account, you’ll pay interest only on $390,000.
You should house every dollar you have in such a parallel account because it will save you roughly 1 percentage point more here than it will earn you in even the best savings account – and because you’ve saved money rather than earned it, you’ll lose nothing in tax.
Think your emergency cash stash, your savings for everything (holiday/car/school fees)… and also consider getting your salary paid into one, using a credit card with a long interest-free period for your expenses during the month and shifting the money across only when the bill falls due.
Say in total you average $10,000 sitting in an offset against that average $400k loan – it’ll save you more than $20,000 and 1.5 years. For free.