The best saving tip for many is to pay their mortgage off quickly

Current interest rates offered on savings account are very low; in the order of 1 to 2%. Likewise, the current interest rates applied to home mortgages are also low. Regardless, the interest component on any 25 year loan can be significant. The simple rule of thumb to remember is; “The quicker I pay off my mortgage the less interest I pay”. This is a cost saving to you. For example on a $400,000 loan with an interest rate of 4.8% and a term of 25 years the interest component alone equals $287,597.

In very simple terms, banks receive income from the interest rate charged on mortgages and loans and it costs them money to pay interest savings deposits. For the bank to make money, the interest rate they charge on mortgages must be greater than the interest rate offered on savings.

“How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case.” - Robert G. Allen

With the knowledge that savings interest rates will always be lower than mortgage rates and with mortgage interest rates at an all time low, what should you do with your own savings?

Your best option is to pay off debts if you have any, which includes your home loan. Almost all of your debts would have an interest rate much higher than what money in your savings account would be earning, which means you’ll get a much higher return on your dollar by making an early debt payment.

Let’s consider if you have an additional $200 each month to save. What return would you get for this $200 if you chose to save it or make additional repayments toward your home loan.

If you deposited $200 each month into a transactional account offering 0.01%, it would take you five years to earn $3. However, if you put this money into a high interest savings account offering 2.75%, you would have earned $30 in one year and $848 in 5 years. Say you have a $400,000 mortgage at 4.8% interest (25 year term), and you chose to make an additional payment to that home loan of $200 per month. After one year, you would have saved $54 in interest and reduced your loan term by 3 months. After five years the return is even greater, saving you $1,532 in interest and reducing your loan term by 1 year and 14 months. Clearly, in this instance, the repayment of debt provides a greater return on your money than a savings account deposit.

And don’t forget, many loan products offer a redraw facility which can allow you to redraw the extra payments in the event you need to use the money for a different purpose.

If you want to know how much you would save by increasing payments toward your home loan, call me on 0413 246 820 or email me at emma@emmamcleodfinance.com.au.