In this article I’ll discuss:
- The myth about offset accounts – are they really that good at reducing your mortgage?
- The biggest danger of fortnightly mortgage repayments
- My top 12 strategies for reducing your mortgage balance faster
- My #1 rule for faster home ownership
At Active Invest a very important aspect to wealth creation is reducing debt. Paying down the mortgage can seem an arduous thought, however there is hope, and following some simple strategies can deliver enormous interest savings and cut many years from your payments. Who wouldn’t like to achieve this!
The Psychology Of Offset Accounts (Do They Actually Reduce Your Mortgage?)
With the introduction of offset accounts over the years and fortnightly repayments offered by the banks, consumers are near on brainwashed into believing this is the only and fastest way to home ownership. Our experience over the years tends to disagree with that simple philosophy and here is why.
Money, the use of money to pay down debt is a psychological state of mind issue and banks over the years play on this basic mindset.
Offset accounts, yes, they will offset your loan balance reducing interest, but that is all they do, you may see a small net reduction in balance as a result. If you look at your offset statement and the balance is $10,000, our experience is that people believe they have surplus money and a high proportion will access this money and not really think about whether the planned purchase is a need or a want.
The psychology with our thinking is the $10,000 should be sitting in the mortgage balance leaving only a small balance in your day to day account. When you go to access funds the balance is lower making you think twice and hard about consuming additional funds for the need OR want purchase.
Yes, this may vary if the property is owner occupied or investment, but let’s just assume you are trying to pay down your principal home. The other psychology aspect with this small change strategy is the balance of your mortgage is reduced dramatically (good feelings) and the interest accrual is still less, no different o the offset account outcomes.
What The Bank Might Not Tell You About Fortnightly Repayments
Fortnightly repayments, yes, we have all heard the bank talk about fortnightly and the savings you can achieve. What the banks do not tell you is that there are two different fortnightly methods, both will deliver vastly different results with paying down your debt faster. The correct terminology for these repayment methods are TRUE Fortnightly and ACCELERATED fortnightly. Let’s look at the two methods and the formulas including the outcomes. Let’s assume your mortgage was $300,000 with an interest rate of 5% per annum over a standard 30 Year term the expected monthly repayment is $ 1,610.00. The banks will say and have said that paying your mortgage fortnightly will save you thousands of interests and many years of loan term. Yes, they are correct in part, as long as you pay on an accelerated strategy.
Here’s the proof and the formulas behind the calculations:
- M = Planned monthly repayment based on scenario above
- 12 = Months in the year
- 26 = Number of fortnights in a year
True fortnightly formula = M x 12/26
Therefore, the repayment using the loan scenario above = $1610 x 12 /26 = $743.08
If you were to pay your mortgage at this value on a fortnightly frequency you will save NO interest and importantly save NO term. So, when the banks say to you we will get you to pay fortnightly, please make sure you do not pay on the true rate as you will achieve nothing other than maximising the interest paid to the bank.
Accelerated fortnightly formula = M x 0.5
Therefore, the repayment using the loan scenario above = $1610 x 0.5 = $805.00
If you were to pay your mortgage at this value on a fortnightly frequency you will save $51,212 interest and importantly save 4 years 9 months off the original term. So, when the banks say to you we will get you to pay fortnightly, please make sure you pay on the accelerated strategy. A dollar saved in interest is worth more than a dollar earned.
12 Strategies To Crush Your Mortgage Balance Faster
Strategies to kill that mortgage, noting all of these apply equally to investment properties if you already own your house. Focus on non-deductible debt if you are an investor.
- Offset accounts, with balance kept as low as possible with actual cash in the mortgage. (investors may vary slightly).
- Accelerated fortnightly repayment.
- Refinance your mortgage to a shorter term, ie 15, 20 or 25 years based on your cashflow tolerances’. This will save you thousands in interest.
- Refinance your loan to a lower rate. Example at time of writing most owner-occupied headline rates can be approximately 3.64%-3.69% with investors headline rates around 3.89% -3.99% depending on payment structures. Conditions apply to the rates mentioned.
- 50/50 Rule, this is where you make a pact with yourself, that any additional income you generate, at least 50% goes directly to the mortgage. Every little bit helps like the tax return etc.
- Direct salary credit is where your paymaster pays a portion OR all your salary directly to the mortgage. This is a great strategy for couples who learn to live off one wage and direct the second to debt reduction. The savings can be enormous.
- Create an Income accelerator for yourself. This is a second job, part-time cashflow you obtain and direct this to debt reduction.
- Cash generate from sale of asset or items no longer used. Do not just throw the items, “one mans trash is another person treasure” they are willing to pay some money for. Use that money to reduce your debts.
- Consolidate high interest debts into lower interest packages and concentrate to pay them off quickly, hopefully improving cashflow.
- Recalculate your repayments based on a higher interest rate ie money today at 3.64% but pay at a rate of 5%. This will save you thousands in interest. This also conditions you psychologically for when interest rates do move higher.
- Split your loan into 2 facilities part being fixed and part being variable. Concentrate of the variable facility by implementing any of the ideas above knowing the fixed portion cannot be impacted by rising rates. Make sure you determine the split loan values to provide you some flexibility in the variable portion. Ie if you can pay an extra $30k per annum over 3 years make sure the variable portion limit is set to a minimum of $90k.
- If cashflow and equity allows, commit to an investment property purchase to accelerate equity growth giving you opportunities to pay down debt faster.
My #1 Rule For Faster Home Ownership
As mentioned early, the banks will have you think the strategies to faster debt reduction are restricted to just offset accounts and fortnightly repayments.
We disagree. The simple rule to home ownership is simply to PAY MORE, MORE OFTEN because interest is accrued daily and charged monthly to your mortgage balance, the more often you can pay with the highest possible value, the interest accruing is restricted and reduced dramatically.
During client finance strategy sessions, we discuss these aspects in detail, because our job is to help you achieve ownership as quickly as possible so you can redeploy equity to build wealth.