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Accelerated debt reduction

March 23, 2024

As expected, the RBA left rates on hold this month and there was clearly some subtle hints that would suggest a cut or too may not be far away. What wasn’t expected was a surprising set of unemployment data that came out the next day that could add uncertainty to the RBA’s interest rate perspective. The latest Labour Force data released by the Australian Bureau of Statistics (ABS) has revealed a drop in the unemployment rate to 3.7 per cent in February (seasonally adjusted).

Whilst this might seem like great news, the RBA actually wants unemployment to be increasing because less people working means less money in the hands of consumers which means less spending and lower inflation.

In this week’s newsletter, we explore simple techniques that can save a borrower thousands of dollars in interest and help them repay their loan in a lot less time.

Making extra or more frequent repayments on a home loan can significantly reduce the amount of time it takes to repay the loan due to the effects of compound interest and the accelerated reduction of the principal balance.

With a typical home loan, the interest is calculated based on the outstanding balance. By making additional repayments, you effectively reduce this outstanding balance sooner than scheduled, thereby decreasing the interest accrued on the loan. Over time, this reduction in interest compounds, leading to substantial savings in both interest payments and overall repayment duration.

Secondly, more frequent repayments can have a similar effect. Instead of waiting for a single monthly payment, making payments on a weekly or fortnightly basis means that the principal balance is reduced more frequently. Since interest is calculated on the outstanding balance, reducing it more often leads to less interest accruing overall.

By accelerating the repayment process, borrowers can also build equity in their homes faster.

Examples

Sarah takes out a 30-year home loan of $550,000 at an interest rate of 6% per annum. Her monthly repayment, calculated using a standard amortisation schedule, would be approximately $3,298.

Over the 30-year period, Sarah would repay a total of approximately $1,187,076. This includes around $637,076 in interest payments on top of the initial $550,000 borrowed.

Extra Monthly Repayments

Sarah decides to make extra repayments of $200 per month, starting from the first month of the loan.

With the extra $200 monthly repayment, Sarah effectively reduces her loan term significantly. By making these additional payments, she would repay the loan in approximately 24 years and 4 months. Additionally, she would save approximately $94,040 in interest compared to the standard repayment scenario.

Fortnightly Repayments

Sarah opts for fortnightly repayments instead of monthly repayments.

By switching to fortnightly repayments, Sarah effectively makes 26 half-payments per year, equivalent to 13 full monthly payments. This accelerated repayment schedule reduces her loan term even further. In fact, she would repay the loan in approximately 24 years and 8 months, saving approximately $79,793 in interest compared to the standard repayment scenario.

Variable

The rates below are based on a $500,000 loan, with the borrower making principle and interest payments with a loan term of 30 years. The rates quoted may vary depending on the borrowers LVR.

1 Year Fixed

The rates below are based on a $500,000 loan, with the borrower making principle and interest payments with a loan term of 30 years. The rates quoted may vary depending on the borrowers LVR. At the end of the three year fixed period, the borrowers interest rate will revert to a standard variable rate for the life of the loan.

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