Principal and Interest Loans

This is the most common home loan written in the Australian mortgage market possibly because it is the most easily understood. In simple terms this is the loan where the interest rate changes as the reserve bank adjusts the price of money and banks change the interest rates to stay in line. As interest rates drop the minimum monthly loan repayment drops and as interest rates rise the required monthly repayment also rises.

As long as borrowers plan their finances for the various changes which can occur from time to time and are able to live within a well-designed household budget, the changes in interest rates may not have any negative impact.

Principal interest loans are more flexible however and borrowers have many choices they can make.

Here are some of the characteristics of a principal and interest home loan.

The interest rate is variable and will change with market conditions.

As long as borrowers pay the minimum monthly repayment they will pay their loan off in the standard 30 years over which the loan is written.

Borrowers have an option to pay more every month so they can pay the loan faster.

Borrowers can choose to make more frequent repayments which will also assist in paying the home loan off sooner.

Some banks offer transaction accounts that can be linked to the home loan so that any excess cash placed in the transaction account will offset the loan balance against which interest is calculated. This is known as an offset account. An example might be where a home loan is taken out for $100,000 and the borrowers have $10,000 excess cash which they placed in an offset account. The interest on the loan is calculated as if the loan balance is $90,000. This means that if a borrower still makes the minimum monthly repayment they will effectively pay a home loan off sooner.

By taking a closer look at how a principal and interest home loan works it’s easy to see how you can devise a strategy to pay the loan off sooner.

As you know, most loans in Australia are written over a 30 year term. This does not mean that you must take 30 years to pay the loan off rather, this is the method bank uses to determine the minimum monthly repayment that will have to be made. As outlined previously, you can pay the home loan off whenever you like although there may be penalties if you pay the layout completely in the first three years.

In fact, you can request the bank to reduce your term if you wish and they will advise you the minimum monthly repayment required under the new conditions. There is really no need to do this however as, if you wish to shorten the term all you have to do is make extra payments. Let’s look at some examples.

How to pay off a home loan sooner by making extra monthly repayments.

Say you have a home loan for $450,000 over a 30 year term with interest rate of 7.2%. The minimum monthly repayment required on this loan would be $3036.33. Let’s assume you can make extra contributions to this loan because you have just received a salary increase of $300 a month. Because you are a savvy borrower you decide to increase your loan repayments by $300 a month to $3336.33. By doing this you will reduce the term from 360 months to 272.8 months effectively cutting seven years off the loan term.

Although this might seem like only a modest change think of it this way. Instead of making 360 monthly repayments of $3036.33 you will be making 272.8 repayments of $3336.33.

Over 360 months you will be making total repayments of $1,093,078.80.

By paying $300 a month extra you will be making total repayments of $910,150.82. That means you will have saved a whopping $182,927.98!

That’s the power of time based interest calculations and by taking advantage of the fact that extra repayments over a long term have a huge impact, you have saved yourself an enormous amount of money.

How to pay your home loan off sooner by making fortnightly repayments.

Let’s look at the same example but this time instead of making repayments of $3036.33 every month let’s pay half of that repayment every fortnight. In other words you would pay$1518.17 every fortnight.

This simple adjustment would take six years off your home loan and using the same calculations you would save $234,035.31. Yet again you can see the power of time based interest calculations and the benefits of making more timely repayments.

Principal and interest home loans are a flexible and effective product that can be used in a variety of ways to help you pay a home loan off sooner. These examples should provide you with an incentive to discuss the options with your mortgage broker so you can get the best out of your home loan at all times.

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