How to reduce your home loan 101
Your home loan, or mortgage as it's more commonly called, is often the most daunting part of getting on the property ladder. Looking at your bank accounts and seeing a sum in the hundreds of thousands is pretty shocking for most and can take a lifetime to pay off. In fact, the word 'mortgage' comes from the old French words for death 'mort' and pledge 'gage'. So in literal terms, to take on a mortgage is to agree to a debt that you may be committed to for some time!
But this doesn't have to be the case. Even though your mortgage can be a large sum there are a number of things you can do to reduce the amount you pay. If maths isn't your strong point then don't worry, we'll discuss how mortgages work, and how you can reduce yours in as simple terms as we can.
WHAT IS A MORTGAGE?
A mortgage is technically the security you provide the lender for advancing you the money, but most people associate the term with the actual 'loan' you take to buy a home. In this article, we'll refer to a 'mortgage' in its common usage as the loan you take out to buy a property.
In general terms you have to front up a minimum deposit to get a mortgage. Currently banks need you to have a deposit of around 20% of the amount you want to borrow. If you want to buy a property for $500,000 then this means you'll need to have access to $100,000 as a deposit. Keep these numbers in mind because we'll use them again later.
The Reserve Bank determines how much lending Banks can approve with smaller savings or equity than the usual 20% deposit. These lending restrictions are based on the LVR or Loan to Value Ratio. So there’s a smaller number of borrowers who might meet these tighter restrictions and be able to have a mortgage to the bank of 90% of the property's value, vs someone that used a 20% deposit - they will only owe the bank 80% of their property's value.
Many people can also qualify for additional grants to help pay for their deposit. Things like the HomeStart grant which you may be entitled to apply for if you have belonged and contributed to a KiwiSaver scheme, complying fund or exempt employer scheme for at least three years. For every year you've been contributing to KiwiSaver the grant entitles you to $3,000 after 3 years; $4,000 after 4 years; up to a maximum of $5,000 after 5 years.
If you're buying a brand new home, a property bought off plans or land to build a new home then you could qualify for $2,000 (after the third year) for each year contributed (ie: $6,000 after 3 years; $8,000 after 4 years; up to a maximum of $10,000 after 5 years).
There are various restrictions on the above based on your income etc, so again it’s best to talk to your mortgage advisor to see which of these apply to you.
If you're nice to Mum and Dad, you might be able to use your parent's house to act as a deposit if you don't have access to the cash yourself (learn more about how parents can help you get on the property ladder fast here). What the bank is looking for is whether your parents have the cash you need as a deposit tied up in the value of their home. This is called equity and can be achieved by either the house value rising, or through them paying off their mortgage over time. If they have the amount you need for the deposit in equity then you might be able to use this to fund the purchase of your home. Again, chat to your mortgage broker and parents to see if this is suitable for you.
CHOOSING A MORTGAGE
There are a lot of variables and product options to consider when talking about mortgages, and this is another reason why a mortgage advisor can help you with the journey. We'll focus on two of the main options borrowers need to think about when taking out a mortgage.
Mortgages, like any other loan, have an interest rate attached to them. This is how the lender makes money from giving you their cash. Interest rates vary and depend on many different factors but the higher the interest rate the more you will pay over the duration (term) of the mortgage.
Fixed rate mortgage
A fixed rate mortgage gives you an agreed interest rate over a set period of time. Because the interest rate and the period are 'fixed' you know what you're going to be paying for an agreed period of time.
As an example, you may be offered a 5% interest rate for 3 years. Because your mortgage is 30 years long (for example) this represents a short period of time where the interest rate is 'fixed' and this might be popular for people who want to lock in a specific budget for their expenses.
Generally interest rates can fluctuate (upwards or downwards) over time for a variety of reasons. This is often influenced by the Reserve Bank reviewing the official cash rate (OCR) from time to time. So while your mortgage is in its fixed term period, you won't have to worry about interest rates going up and your payments increasing. Likewise, if the interest rates drop then you'll be stuck paying the higher amount until your fixed interest rate period expires.
Variable rate or floating rate mortgage
A variable rate mortgage is susceptible to economic and market conditions, so the interest rate may increase or decrease at any time . As it drops your mortgage repayments will also reduce; as it increases your monthly/fortnightly repayments will also increase.
Whether you start with a variable rate or a fixed rate, smart borrowers will regularly review their mortgage structure to ensure they're getting the best value possible.
One of the benefits variable rate mortgages have over fixed rate mortgages is that you're free to make lump sum deposits to your mortgage at any time, which is something you're often restricted to with a fixed rate mortgage.
REDUCING YOUR MORTGAGE PAYMENTS
Now that we have covered the two main interest rate options of a home loan, we can now look at ways you can significantly reduce the amount you owe the Bank over time. You will be paying back the $400,000 you borrowed ($500,000 minus the $100,000 deposit) plus a hefty chunk of interest.
The interest is the kicker. Let's say you get a 5% interest rate over the course of your loan. You might think 5% of $400,000 isn't too bad - that's only $20,000 after all. But mortgage interest is calculated on the daily outstanding balance of your loan, and this can add up to a huge amount over the full term of the loan. Assuming the interest rate never changed (just as an example) and you repaid this mortgage at the minimum monthly amount of $2,147 over 30 years, here's what you would have paid off once you’re finally debt free:
Principal reductions = $400,000
Interest Component = $373,023
Total Repayments = $773,023
There are many ways you can save huge amounts (sometimes six figures !) over the term of your loan, but you need to know all the tricks to achieve this. This might involve simply changing your monthly repayments to fortnightly repayments; increasing or rounding up your repayments; making occasional lump sum payments from bonuses or asset sales; reducing the term of the loan; and many more. A mortgage advisor can tell you exactly how much you will save using any of these techniques, but the secret is to regularly review your mortgage structure.
WHAT CAN I DO?
The top of your list should be to see someone who can provide you with accurate and trusted advice. Our team of mortgage advisors at Stephanie Murray Mortgages are highly trained in all facets of property financing. They take great delight in saving you considerable amounts of money over time by regularly reviewing the mortgage structures you might have in place.
They will work closely with your existing Bank to obtain the very best deal for you, and if there's a better option in the market then their job is to let you know what your other options are.
Book a FREE chat with one of our trusted Mortgage Advisors to see if you could reduce your mortgage payments and save a bundle. You won't pay for their advice and they will consider your individual circumstances before suggesting alternative options.