How to pay off your mortgage faster

Paying off amortgage is one of many New Zealanders’ top financial goals – usually coming right after buying a house and taking out the loan in the first place.

But while many people expect to live with their loans for 20 or 30 years, there are ways to make sure that you pay yours down faster. This can save significant amounts of money. A $500,000 loan paid over 30 years costs $258,573 in interest, even at an interest rate of 3 per cent. Paid over 20 years, it only costs $165,191 – and you have an extra 10 years with no repayments.

Tom Hartmann, managing editor at the Commission for Financial Capability, said people should understand thatmost mortgages were structured entirely in the lender’s favour.

‘‘Every dollar you put above the minimum repayment is restructuring it more in the borrower’s favour.’’

Because home loans run over a long period, even a small increase in payment canmake a big difference.

A $500,000 loan at 3 per cent interest over 25 years will have a fortnightly payment of about $1095. An extra $100 in repayments a fortnight, or $50 a week, will reduce the term of the loan by three years.

Sometimes you don’t even have to increase your payments to get the benefit. In an environment where interest rates are dropping, keeping your payment level constant while you move to a sharper rate means you chip away at the balance more quickly. If your interest rate fell from 4 per cent to 3 per cent on that same $500,000 mortgage, you could also take an extra three years off the total loan term if you did not let your repayment amount fall.

Hannah Mcqueen, financial coach and founder of Enable Me, said paying amortgage faster would require a ‘‘multi-pronged’’ strategy.

‘‘But it starts with the basics: maximising your personal cash surplus – that is, how muchmoney you have left over after all your costs are covered. You need a plan to create one, maximise it, and maintain it – because that doesn’t tend to be most people’s default position.

‘‘People tend to get very focused on securing the lowest possible mortgage rate or the highest investment return – which is important – but you shouldn’t overlook the impact improving your own financial behaviours can have. In our experience with our clients, about 15 per cent of your income can be found and put to work, which is very powerful.’’

She said people would need to understand howmuch they were capable of paying off over a time period so that they had a clear goal to work towards. ‘‘Tracking is important to keep you accountable, and seeing the progress is a huge motivator that the effort is worth it. Psychology plays an important role, particularly when you’re dealing with large numbers that can seem insurmountable in the short term.

‘‘You need to structure your mortgage so you’re not stung with fees for paying it down faster, and you also need to be able to reaccess that money to help protect you in times of volatility.

‘‘You need to be considering what you’re doing outside of your mortgage payments to improve your household’s balance sheet. That might be using your equity to invest in something else, like a business or an investment property, and then using the profits or capital gains to reduce your mortgage or further invest.’’

Most lenders will allow people to make extra payments on their home loans. Otherwise, you can move to higher repayments when your fixed term ends, or use a revolving credit facility to pay an amount down quickly.

That is an approach that financial adviser Liz Koh favours. She said a borrower could carve off $50,000 of their loan into a revolving credit account, which acts a bit like a big overdraft. Then, they could put all extra cash into that account to pay down the amount they owed – but with the security that they could access it if they had to.

‘‘Your mortgage can be divided into ‘chunks’, one of which is a line of credit. Let’s say you have a mortgage of $300,000 and, with two incomes in the household, you believe you can save $1000 per fortnight. You can set up a line of credit of, say, $30,000 and two table mortgages, one of $135,000 with an interest rate fixed for one year and one of $135,000 with an interest rate fixed for two years. Each fortnight you pay $1000 into your line of credit so that, by the end of a year, providing you have not needed the money for anything else, the balance is now down to $4000 owing and you can draw down up to $2000 if required.

‘‘The chunk that was fixed for one year is now waiting to be fixed again, but before you do so, you can draw down say $20,000 from the line of credit and use it pay off part of the $135,000 table mortgage, leaving a balance of $115,000 to be fixed again for a period of, say, two years.

‘‘Your line of credit will now be $24,000 owing, which leaves you an emergency fund of $6000 which can be drawn down if necessary. Now start the process all over again. Keep paying $1000 per fortnight into your line of credit. At the end of the next year, the second chunk of $135,000 will no longer be fixed and you can draw down funds from your line of credit to pay off part of it before fixing the rate again for two years.’’