young couple in their new home

Mortgage Advice for Young Couples Part 3: The Best Home Loan Structure

In Mortgage Advice for Young Couples, Mortgages by Phil McGilvrayLeave a Comment

In the first blog in this series, Mortgage Advice for Young Couples Part 1: How Much Do We Need to Save For a House?, I provided an overview of how much you need to save before buying a house and outlined all the costs you need to consider.

In this second blog, Mortgage Advice for Young Couples Part 2: How Much Can We Afford to Spend on a House?, I outlined the process I use with all my clients to help them identify how much they can afford to spend on a house.

Now I will talk about, the do’s and dont’s for the best home loan structure. I understand that a blog on ‘loan structures’ is hardly riveting reading – it’s probably up there with life insurance in the top ten most boring topics to read about. However, like life insurance, how you structure your home loan can have a significant impact on your financial future. If you are looking at getting a home loan or have a home loan, it’s time to do a few star jumps, grab a cup of coffee and read on.

Over the past 20 years the banks have cleverly engineered their loan products and their marketing to ensure that the majority of the population will still be paying off their home loans at retirement. Unless you are purposeful about managing your mortgage on your terms, you will spend a significant proportion of your life working just to pay the interest on your home loan. 

The reality is, with focus and a little sacrifice just about anyone can have their mortgage paid off inside 10-15 years and in doing so save themselves hundreds of thousands of dollars.

So here are some dos and dont’s that will help you knock off your home loan in extra quick time:

Do not
get a redraw facility

I cannot reinforce this enough, please do not allow the banks to talk you into getting a redraw facility. A redraw facility is simply where the banks gives you the capacity to redraw (take back out) any money that you have paid off the loan principle. With each loan repayment you make, a portion of that loan payment is paying down the amount that you owe. In most cases, those loan repayments will ensure you have your home loan paid off in 30 years. That is of course unless you dip into the money you have paid off via the redraw facility to buy a car, go on a holiday or pay off the credit card. I see too many people destroying their financial futures by using the home loan as a massive slush fund – don’t let this be you.

Get an offset account 

An offset account is simply a bank account that sits alongside your mortgage. Any money sitting in the bank account is considered the same as principle paid off the mortgage. So if you have a $100,000 home loan and are paying 5% in interest you will pay $5,000 in interest. If however you have a $100,000 loan with $10,000 in your offset account the bank will only charge you interest on $90,000 ($100,000 – $10,000). So instead of you paying $5,000 you only pay $4,500 in interest. 

The best part about this is if you had put your $10,000 into a high interest savings instead of an offset account you may have earned 3% or $300 if you were lucky and then you would have had to pay tax on that $300. 

By having funds in your offset account you not only save yourself $500 ie $200 more but it is also all tax free because you have saved it, not earned it!

Most banks will give you the option of at least one offset account. I typically recommend you use the offset account as your long term savings account. Be aware that some offset accounts come with limited functionality ie minimum withdrawals of $500 and no B-pay or periodical payment options, which is why they are good savings accounts but not so good as working accounts. 

In recent years many banks have loan product packages that do include a number of working bank accounts that are all offset against the mortgage. This is ideal if you can get them, just make sure the annual package fee is comparable with other products.

Final note: the banks and mortgage brokers will try telling you a redraw facility does the same things as an offset account, this is true in theory but in reality there is a massive difference. You want an offset account not a redraw facility.

Do not
pay your income into home loan and live off your credit card

Another very popular loan structure in recent years has been to have your pay transferred directly in your home loan and then to pay for all your living expenses on a 55 day interest free credit card. 

At the end of 55 days you pay off the credit card from the loan. By having your pay sitting on the mortgage for that 55 days you do actually save interest. The banks will show you compelling charts indicating how much faster you would pay off your mortgage. While this is true I have only ever met one person disciplined enough to make it work.

What ends up happening is that the credit card bill exceeds your pay and the balance of your loan remains stagnant or worse grows larger. Don’t go there!

Break your loan into chunks

When you have a large home loan, the idea of paying it off can feel like an insurmountable task. The most common response to an insurmountable task is that we give up, instead of aggressively attacking the debt. We make the monthly payments and not much more, resigned to the fact that it will take us 30 years to pay it off. 

Instead of being overwhelmed by the size of your home loan, break your loan into chunks. Right now with interest rates at record lows many of my clients are asking about whether they should fix home loans. There are many pros and cons to fixing a loan which I won’t go through in this blog, however one massive positive of fixing loans at the right time is that you can isolate parts of your loan.

If it is a good time to fix loans, I encourage my clients to identify how much loan they believe they can aggressively pay off over two years, that they leave this amount variable and then fix half the balance for two years and maybe the rest for 5 years. Instead of focussing on the full loan, their goal is now to knock off the variable portion of the loan within two years. This is just in time for the 2 year fixed interest loan to mature, at which time the process can be repeated.

The key to getting a loan structure that will allow you to pay off your home loan in extra quick time is to keep things really simple. You don’t want redraw facilities, lines of credits and fancy payment systems. Your mortgage should be sacred and the loan balance should go down, never up. Where possible use offset accounts to save for emergencies and big upcoming expenses. And finally, get comfortable with your home loan, being purposeful about paying it down will ultimately save you hundreds of thousands of dollars.

Remember the key is to keep it as simple as possible….. and you do not want a redraw facility!!


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