Q: My home mortgage is currently principle and interest paid fortnightly. Would I be better off using an offset account for my savings and pay interest only? Which strategy will equate to a more rapid mortgage reduction?
A. The most appropriate loan structure and repayment method will depend on the interest costs of your loan, your income, your cash flow needs and how disciplined you can be around money and debt reduction.
Principle and interest (P and I) loans work best for those who want the certainty of knowing the loan will be paid off on or before a pre-determined date. Borrowers are often motivated by seeing the loan balance diminish on a monthly basis. They may want or require the forced discipline of regular principle payments. P and I loans are typically offered by lending institutions for between 1 and 30 years. Obviously, the difference in loan term duration will determine the size of the contracted monthly payment and the ultimate amount of interest you pay.
Interest Only (IO) loans work best for those who want the lowest minimum monthly repayment on a mortgage or do not wish to focus on paying the debt down immediately. Borrowers may require greater flexibility as to how and when they reduce the debt. Whilst the loan term may be up to 30 years, typically the loans revert to P and I after say 5 years IO. Typically they suit those who have an investment property or who wish the minimum obligatory payment to be as low as possible.
Fortnightly loan repayments are an effective means of paying back a debt quicker. There is no great mystery to why; a fortnightly loan repayment is set at half the monthly loan payment obligation, however, there are 26 fortnights in a year so you make an extra monthly loan repayment a year.
As the name suggests, an Offset account offsets the balance of the account against the outstanding loan balance. Mortgage interest is typically calculated on a daily balance so the more you have in the offset account and the longer you retain it in the account, the greater the interest offset.
Whether you pay more off the actual loan or leave more in an offset account, they have the same effect on the interest charged.
In deciding whether to have a P and I or IO loan, consider your cash flow requirements; can you afford higher minimum payments associated with a P and I loan or do you require the comfort of a lower minimum payment in the event of a change in circumstance?
Q Our current mortgage debt is $370,000. I have been offered what I believe to be an excellent mortgage rate of 3.89% fixed for 2 years. My current variable rate loan is 4.2% p.a. Should I fix my home loan?
A. As a general principle, you should only consider fixing a home loan in the following situations; Fixed rates are lower than variable rates. Your family’s cashflow is tight and your mortgage is of a size that if interest rates were to move, they would significantly impede your ability to service your debt. You were of the opinion that interest rates were likely to rise in the future. Or if you wanted the certainty of knowing what your mortgage costs were likely to be.
If you are basing your decision purely on the direction of interest rates, for you to be worse off by fixing, you would have to assume the Reserve Bank was to cut interest rates further and lending institutions would pass those cuts on to borrowers.
I would only fix the portion of the loan that you felt you would not be able to repay over the length of time the loan is fixed. For example, if your loan was $450,000 and you felt that you would be in a position to make additional payments beyond your mortgage obligation by $2,500 per month, I would fix no more than $390,000 for the 2 years and leave the remainder as variable and pay down quickly with the additional payments.
Consider establishing an offset account that your income is paid into. Link this to the variable portion of your loan. As the name suggests, the account balance of the offset account offsets the interest charged on the variable portion of your loan. If you wish to fix a portion of your debt, establish a fixed term sub account that the repayments are serviced by the offset account
A disadvantage of fixing is that you are locked into a lender for the duration of the fixed rate period. To break a fixed rate loan may incur costs that could make moving loan providers unviable.
The rate quoted appears competitive but shop around, rates and features constantly change.