By Laurence Smith, Financial Adviser, UEM Wealth, Authorised Representative, Lifespan Financial Planning Pty Ltd AFSL 229892
Home ownership remains the great Australian dream. Based on information from the last completed Census (2021), of the 9.8 million dwellings in Australia, 3.26 million of them were owned with a mortgage attached to them. While mortgage providers offer different packages and product features to suit differing needs, there are some key components (outlined below) that form a part of almost every mortgage.
Principal – this is the amount borrowed and still owed on the loan.
Loan-to-value ratio (or LVR) – an expression as a percentage of the outstanding principal divided by the value of the property that the mortgage relates to. For example, a $500,000 loan outstanding against a $1,000,000 home would present an LVR of 50% ($500,000/$1,000,000).
Interest – the rate of borrowing on a loan, normally presented as a percentage. The rate typically reported on home loan documentation is often the ‘nominal’ rate, meaning it is the stated annual interest rate for the loan. This differs from the ‘effective’ rate of the loan. The effective rate of interest is calculated by dividing the annual nominal rate by the number of days in a year (i.e., by dividing it by 365). This is then applied to the outstanding principal every night, and interest at this rate is accrued towards the overall interest expense each month.
Repayment Period – how frequently loan repayments must be made, e.g. weekly, fortnightly or monthly.
Repayments – the amount due each period to pay off the loan.
Amortisation – This is a term used to describe the interaction between the principal, interest rate, and repayments. It typically describes the length of time it will take to repay a loan.
Low Doc Home Loan – usually the most basic home loan offered by a lender. These loans may offer a slightly lower interest rate and may only be available to certain borrowers for a certain period of time. They normally offer basic features only.
Redraw – a redraw allows a borrower to make additional repayments into the principal of a loan and then access the additional funds if needed.
Offset account – An offset account is a type of bank account linked to the home loan. The balance held overnight in an offset account will effectively reduce the principal owing when interest is calculated.
Because of the impact of interest, it’s convenient to think of a home loan in three phases. For the first third of the amortisation, most of each repayment goes towards funding interest expense rather than reducing the principal. Generally, only 17% of the principal owed on a home loan will be repaid in the first third of the loan term. During the second third of the loan term, the repayment rate starts to accelerate as more of each repayment is directed towards the principal rather than being used to cover interest. Typically, another 30% of the home loan is repaid during this period. Finally, the remaining 53% of the home loan is typically repaid during the final third of the loan’s life.
There are some tried-and-true strategies used to accelerate the repayment term of a home loan; however, they all generally come down to temporarily reducing the principal owing to reduce the interest expense over the course of the loan. These commonly include making additional repayments (so that less interest accrues each month), depositing extra funds into a redraw (almost like using the redraw as a savings account), or running lifestyle expenses through a zero interest credit card to leave funds in an offset account (then repaying the credit card in full). Other more ambitious strategies may involve directing excess cashflow towards investments rather than making additional repayments, with a plan to utilise future earnings to make a lump sum repayment.
Whichever strategy is preferred, it must fit into the way that you would normally manage money. A qualified financial adviser is well-positioned to discuss any of these strategies and help determine which strategy will be most useful to apply to your lifestyle.
DISCLAIMER General Advice Warning – this is untailored, general advice. It does not take into account your personal circumstances. You need to decide whether it meets your needs. Laurence Smith is an Authorised Representative and UEM Wealth Pty Ltd is a Corporate Authorised Representative of Lifespan Financial Planning Pty Ltd (AFSL 229892). Laurence Smith may offer services through UEM Wealth and UEM Group. Accounting services are provided by UEM Group. Financial Services (financial product advice and dealing) are provided by UEM Wealth. To the extent permitted by law, although the same adviser may offer you services under the above business, each business is solely and separately responsible for the advice they each provide.
