Are You A Credit Risk? How You Can Check Your Credit Score Now

It's been a few years since I checked my credit score. Have you checked yours recently? If you want to borrow money, it's a good idea to go take a look at your credit score first. You don't want to keep applying for loans or accounts and get a lot of rejections as that could result in further deterioration of your credit score.

You can get a free online credit report check instantly from www.getcreditscore.com.au or by mail from veda.com.au

Why is your credit score so important? It can influence your application for utility or new loans by being declined, being approved but as high risk and thus higher interest rate, or as a good risk and offered cheaper loan rates. It roughly tells creditors how 'financially responsible' you are. 

Nicole Pedersen-McKinnon had a reader write in to ask about how she could fix her "below average" credit score of 230 (out of 1200). She advised that if you have a poor credit score, contact those that you owe money to, pay them back in full and request that they update your file as "fully paid". The details will unfortunately be on your file for 5 years from the date that you incurred the debt. So the faster you act, the better.

Out of curiosity, I checked mine and what a relief it was that it was nothing funky (I'll settle for ordinary and that's what I got)

And what does it mean? 

So my credit score is 927 out of 1200. On the upper tier so that is a relief, but nothing special. A range of factors affect your rating. I wonder what it takes to achieve a credit score of 1200? Having absolutely no mortgage or personal loans? No credit cards? Doing nothing financially risky? 

Reverse Mortgages Suck: Don't Use a Reverse Mortgage If Other Options Exist

After seeing the option of reverse mortgages being mentioned in the papers too frequently as an option for 'asset rich retirees who are income poor', I just have to put my thoughts out there for those who are investigating reverse mortgage as an option.

Don't take out a reverse mortgage if you can avoid it.

You have probably spent the past twenty to thirty years paying off your mortgage where the first ten to twenty years was all interest payment and barely any principle. Do you really want the amortisation to work against you again in the last decades of your life when you should be enjoying life?

With reverse mortgages, there are no repayments, loan interest is added onto the principal amount borrowed to be paid off when the property is sold. The debt will grow fast. It will be interest debt compounded with interest charged on interest. 

Compound interest works in your favour when you put your savings in the bank. Interest charges compounded year after year will destroy the equity in your home when it's left to accumulate in the typical reverse mortgage structure.

Ever heard of a loan amortisation schedule? I really recommend looking it up if you haven't. 

When someone buys a property and takes out a mortgage, the first few years of payments will be almost all interest and barely any principle. Most people's eyes will glaze over when they read about an amortisation schedule and the break down of interest to principle in a monthly repayment. Let me illustrate with an example:

Scenario: Jack and Jill takes out a mortgage for $300,000. Principle and interest. 30 year term. Interest rate of 5%. 

1.Principal and interest monthly repayments = $1610.46 ; interest=$1250.00, principal=$360.46

2. After 195 months (just over 16 years!) = P+I monthly repayment =$1610.46; interest=$802.88, principal=$807.59. The monthly repayments will now start eroding your loan principal faster and faster from 195 months

3. After 360 months (30 years)= P+I monthly repayment =$1610.46; interest=$6.68, principal=$1603.78. Loan is finally repaid

With a reverse mortgage, you would replay that scenario backwards! Where the 360 month(30th year) redraw from the mortgage of $1610.46 means $1250.00 is the interest charge and you effectively get only $360.46 to spend out of that $1610.46.

But you don't need that much? But you won't be redrawing for that long? It doesn't matter how much or the time frame of the redraw, the amortisation schedule is an eye opener and you are really giving your future, older self a hard time if you take out a reverse mortgage because the interest charge compounded on interest will erode your equity.

You could live to 100 years old and beyond. You could be homeless. I'm not even being dramatic. It's just the way the maths work. So don't take out a reverse mortgage if you have other options or you can avoid it. Just thought I would analyse that for anyone who is trying to do research because it is such a detrimental option but it is being bandied about in the news as an attractive option with no draw backs mentioned or high lighted.

I haven't come across a single article in mainstream news yet that highlights and objectively analyses the pros and cons of reverse mortgages. Only the benefits are discussed. 

Motto For Wealth: Maximise Income And Minimise Expenses

The story of how to get rich has been trampled over many times by writers, entrepreneurs and dreamers. Even dreamers know the theory but they don't actively apply the theories. For you to grow your wealth and find the holy grail of financial independence, you need to apply all these 'how to get rich theories'.

The very root of how to grow your wealth is really very simple.

Maximise your income by investing in your skills and abilities and therefore you can demand a higher price for your knowledge and skills. On the other hand, you minimise your expenses by actively reducing your spending or reducing your recurring expenses. 

I wanted to write about my most recent experiences about reducing recurring expenses. Most of us dislike having to review our insurance bills, our mortgage bills, having to change banks and calling up for quotes.

Having remained with the same bank and same insurance provider for years and years which led to complacency, over the last few months, I thought it was time to take a look at my expenses. A good thing that I did that because my current bank and insurance providers were really having fun at our expense.

1. Cheaper Insurance Policies

Mr SMG and I had seven insurance policies with our current insurer and they gave us a 25% multi-policy discount for having multiple insurances with them covering houses, contents and cars. The 25% 'loyalty' discount is fine and dandy but it really is rubbish when there are more competitive insurers out there that don't even offer the multi-policy discount when they quote but are priced competitively to try and get your business.

 A different major insurer offered the same comprehensive insurance at a few hundred dollars cheaper and that was for just one policy. By staying with the previous insurer over the years, they simply kept increasing our premiums every year citing, "there may have been increased theft in your area, there may have been more accidents in your area...blah blah blah." 

2. Cheaper Mortgage Interest Rates

Most of us are aware that there are different tiers of mortgage rates out there depending on how much you borrow, the calibre of yourself as a borrower and how much business your provide to your bank (the more fees they earn from you from investment products, the more they love your business). I did some research on the internet and read that some were offered up to 1.3% discount off the standard rate. So I went to ask for interest rate discounts above what we were being offered at 0.91%. It was like hitting a brick wall, "No, no, no, we've given you the best discount that we can offer.". 

If at first you don't succeed, you try and try again. So I asked again and then they offered me a 1% discount. A few weeks later, I asked again. I knew there were better rates out there. I was prepared to change my bank but it is rather inconvenient so if they offered me something more competitive, I would remain. I got referred to a personal banker. He obtained a 1.2% discount off our standard variable rates. That 1.2% discount over our current 0.91% discount is going to save us thousands and thousands of dollars across our multiple mortgage loans. Unfortunately I can't quantify it for readers since Mr SMG and I combined our finances. He is a lot more of a private person than I am. It took several visits and phone calls but it was worth it.

3. Question Your Bills and Expenses

This point is mainly for Australians and not for international readers. The NSW Valuer General does the valuation on raw land values every four years. If you own any property, you have to pay council rates. The council uses the Valuer General's figures on your land value to calculate the amount of rates that you have to pay.

Previously, our land was valued at $585k. That's just for the raw land and the dirt underneath our feet. The recent valuation last year came in at $827k. Which is ridiculous having looked at recent sales in our area last year. With a land valuation of $827k and if anything happened to our house and we had to replace our four bedroom house at $500k(for the same house size that we have now), that would value our property at approximately $1.3m plus. Last year, I thought that was out of the question so I wrote to object and they sent a personal valuer out to check out our land. The value was revised downwards to $780k which meant that we saved about $500 in rates payable. That email took 30 minutes to compose and send and it saved us $500.

Having noted recent sales however, the Valuer General's figure was probably spot on for this current market but it wasn't appropriate for the property market last year. We'll just have to take advantage of that for the next four years. Two weeks ago, a house near us sold for a ridiculous $1.7m plus figure and that was just insane but this is the crazy Sydney property market where insanity is the new norm.

The motto for growing your wealth is as applicable as ever. Before we focused on growing our investment income but didn't really focus on minimising expenses that much. It was only when I looked at our bills and realised that all our recurring providers were just increasing our bills beyond inflation and every single year did I realise that it was time to review other providers. It's not fun but it's something that needs to be done.

As the treasurer for one of our strata block properties, I changed the gardeners and cleaners who were charging us $18k for the year to one that charged us only $14k. The previous contractors were simply increasing their fees by almost $1k per annum. With the replacement contractors, the quality and standard of the garden and block is exactly the same. That saved $4k per annum for the past five years which is a $20,000 saving. That was just one aspect.

Don't accept everything that is given to you as fact or as something that you just have to put up with. Question it. Ask around for quotes and be prepared to change providers. Can't emphasise that enough.

Henderson Poverty Index And Household Expenditure Measure

Have you heard of the HPI (Henderson Poverty Index) or HEM (Household Expenditure Measure)?

HPI and HEM are the living expense amounts that lenders use in their mortgage calculators to see how much you can borrow.

Some home loan lenders have started using the HEM to calculate the maximum size loan you can borrow based on your income. Using HEM in calculations means individuals can borrow more while it's the inverse for couples, that is couples can borrow less when the HEM is used.

When you apply for a mortgage loan, the paperwork will ask you to state your living expenses and how much you spend. With those figures, they will compare it to the appropriate category in the tables below and take the higher figure to use in their mortgage calculators.

Living expenses for single adults

Household Segments	HPI	HEM
No Dependents	$1250	$1105
1 Dependent	$1717	$1430
2 Dependents	$2159	$1560
3 Dependents	$2601	$1889

Living expenses for couples

Household Segments	HPI	HEM
No Dependent	$1817	$2032
1 Dependent	$2284	$2583
2 Dependents	$2726	$2704
3 Dependents	$3168	$3137

If you're single, is $1105 per month sufficient to meet your living expenses?
If you're a couple, is $2032 per month sufficient to meet your living expenses?


Source:
1. homeloanexperts.com.au

Borrowing $400,000 from the bank

Whoa, I can borrow more than $400,000 

My bank ran some preliminary numbers and said that they can probably arrange a pre-approval for me to borrow $400,000. And that's on top of my current loan commitment. The average Australian loan is about $360,000. If I were to fully leverage myself, then my aggregate investment loan balance would vastly exceed the average loan.

Would you borrow that much?

If your bank offered you an additional loan of $400,000, would you accept their offer?

I'd be crazy to borrow the maximum amount and gear myself to that extent. It's a bad move to over-leverage and also a bad move to under-leverage.

Why is it bad to be under-leveraged? Currently, I'm under-leveraged which means that I have the potential to buy more investment assets and service a greater loan. This can potentially translate to greater passive income and capital gains but I'm not taking advantage of that because I'm under-leveraged. Next year I plan to buy another investment so that should sort out the under-leveraging situation. Although I wouldn't borrow the maximum because that could topple like a house of cards.

Why is over-leveraging risky? No-one should be borrowing up to their maximum servicing capacity(your ability to repay loans) because it doesn't leave any rooms for errors, disruption to the income stream (job loss or fluctuations in business revenue) and it'll probably be rather stressful when you're walking on a financial tight rope. If you subject yourself to high risks, then you're subjecting yourself to the risk of having to liquidate your investments (shares or property) at an inopportune time, therefore, realising your losses and not having the ability to ride out asset price fluctuations.

How do you work out repayments?

I use my favourite site yourmortgage.com.au for their advanced repayment calculator. Although I've compiled my own spreadsheet with inbuilt formulas so no longer use this site but I recommend this one. Why? They have a fantastic loan repayment calculator. It's accurate and doesn't do shabby rounding ups and downs that ultimately give users inaccurate numbers like some of the other online calculators that I've checked out.

A loan of $400,000 at 8% for a loan term of 30 years means repayments of:

$2935.06/month OR
$1354.06/fortnight OR
$676.91/week

Of course, if you are buying an investment then you'll be earning investment income so that could contribute towards the repayment. If you're in Australia, then you also get a tax deduction for interest paid and a raft of other tax deductions associated with the maintenance of your investment. After all these deductions, the cost that's coming out of your own pocket is significantly less.

What if I want to instead, maximise my borrowings?

If I really wanted to borrow the maximum, then I would be refinancing my current investments down to a loan valuation ratio(LVR) of 20% so that I could borrow up to 80%.

By doing this, then for every $1 that I have, I can borrow $4. This is how I can fully gear myself and risk over-leveraging:

• If I have $100k then I can borrow $400k for a $500k investment.
• If I have $200k then I can borrow $800k for a $1 million investment.
• If I have $300k then I can borrow $1.2 million for a $1.5 million investment

Generally, you can maximise your borrowings and fully gear yourself without paying lenders mortgage insurance (LMI) if you have at least 20% to deposit.

Further reading:

1. 15 Tips On Paying Off Your Mortgage Faster
2. Understanding Loans and Their Features
3. Paying off your mortgage faster - The scenarios

Rule One: Never Lose Money

"Rule One: Never Lose Money. Rule Two: Never Forget Rule One."
Warren Buffet

A more classic take on not losing money would be the old proverb, 'A fool and his money are soon parted'. If you don't treat your capital with care and consideration, then expect your capital to be lost or diminished over time.

Over the recent years, I've had many opportunities presented to me in the form of business ideas, ventures, partnership and pretty much anything where particular friends have been short of funds but think that they've got a good venture to offer to me.

The only time I've ever asked for capital was several years ago when interest rates for savings account were at 1% to 4%pa and I didn't want to risk 100% of my savings in the stockmarket until I'd saved a bit more. Inbetween low yield savings account and the high risk stockmarket, was the bond market. Corporate Bonds. They were offered by the major banks in Australia and probably by other investment banks but I didn't look at the investment bank offerings.

To invest in Corporate Bonds, the minimum capital requirement was $100,000 and I didn't have that capital so I had to try and raise some funds.

The yield was about 5%-7% and it was better than the interest returns we were earning individually on our savings account. Anyway, I could only rustle up an aggregate $80k so it wasn't sufficient. I was accepting all the risks and said that I would re-imburse any losses whatsoever and split all the gains with no accounting for the risks that I was accepting on everyone's behalf, simply because I wanted to experiment with other investment options. 

The risks of default on the Corporate Bond depended on who the Corporate Bond holder was and I was only going to invest in a Blue Chip company bond. Typically, the higher the risk of bond default, the higher the yield. However, my goal wasn't to maximise the yield. It was only to earn more than the low interest rate on savings account available at that time and yet not expose myself to the higher risks of the stock market.

Anyway, fast forward to now, I haven't asked for capital since and I don't need anyones capital anymore to enter into any investments that interests me. I have my own capital for doing whatever I want.

Because of that, over the years, I have had many business ventures proposed to me. Seeking venture capital or partnerships for cafes, restaurants, take aways etc. On average, the typical amount that I've been asked to lend ranged from $50k to $100k. That's a lot of money when the venture has multiple partners and multiple interested parties.

The problem with diluted ownership in ventures with multiple partners is that you lose control in terms of decision making. It becomes more the case of 'majority rules' and because of that, it means you risk subjecting your capital to greater risk of loss. For me, that's a huge detraction. I'm not interested in investing in any venture where I can't control the outcome directly but can only influence the outcome to some extent.

A friend of mine has recently asked me if I wanted to invest $50k with a partnership of four(total investment capital $200k) into a cafe with her uncle as the chef. So what was the problem with her proposal?

• Firstly, her uncle would not be injecting any capital.
• Secondly, the business' success will depend on mainly his performance.
• Thirdly, I knew her and trusted her, but I did not know her uncle and I had no idea about how professional and dedicated he was to the food industry or how much I could trust him

If her uncle decided to throw in the towel and quit, what is going to stop him from walking away? He's not risking any of his money so what's going to stop him from quitting at an inopportune moment? Even if you reinforce his employment with a contract, if he wants out, he could burn all the food or give poor service, leaving you no choice but to terminate the contract. What if the business was built around him and he decided to leave?

There have been friends in the past who invested and lost, telling me that I was lucky not to have thrown my capital in with them. A the end of the day, it's not a question of luck. It's a question of judgement and analysing your risks and deciding what happens in various scenarios and what the possible outcomes could be. And if the potential scenarios aren't great, then having the gumption to say that you're not interested in investing.

Understanding loans and their features

Loans can have a fixed or variable rate of interest, be secured or unsecured, negotiable interest rates and payment terms. There are many different types of loan available.

Fixed or Variable Interest
1) Fixed Interest – Interest is fixed for the duration of the loan, from the time it’s taken out to the day you pay it off.

2) Variable Interest- The rate changes either up or down depending on the market rate (which varies depending on the loan type eg: LIBOR, Bond, Central Bank rates).

Secured or Unsecured
1) Secured – Then lender can sell whatever asset you’ve secured the loan against if you default and can’t pay the loan. Assets typically used as security are houses, cars, stock portfolios and personal possessions. Loans that are usually secured are car loans, mortgages, mortgage line of credit accounts

2) Unsecured- The lender has no recourse. You’ve got not asset with the lender as a collateral. If you default on the loan, the lender considers you a bad debt and will most likely pass you along to the debt collection agency as a last resort. This loan is riskier for lenders so they usually charge a higher interest rate because of this increased risk. Examples of unsecured loans are credit cards, store cards, personal loans and personal lines of credit

The different type of loans available are:

Car Loans
Car loans are usually secured against your vehicle. They may insist on car insurance as well. You should shop around for the best financing deal first before going shopping for a car because car yards will always have their own financing but this may not be the best deal around.

Car loans are usually for a fixed amount of money, organised upfront with a fixed interest rate, repayment amount and period. Example: $10,000 car loan at 10% interest, repayable by monthly instalments for the duration of 4 years.

Credit Cards
If you can’t pay off a credit card every month before the interest free period ends, then don’t use a credit card. If you don’t listen to this wise and sagacious advice, then it will ultimately be your downfall. You only need one or at the most two credit cards ever at any period of time.

These beasts come in various structures with interest free period ranging from 0 days or 55 days to 6 months typically. Read the fine print! Understand what you are signing up for. Don’t be fooled into thinking that it’s worth spending on the credit card because you get reward points or frequent flyer points. Wow, you’ve gone and spent $3,500 so that you can collect 3500 points, the equivalent of $25-$30 in rewards – if you can't pay that $3,500 off before incurring interest charges then it's a bargain with the devil.

If you can’t pay them off by the interest free period, you will be paying through the roof with rates ranging from 11% to a more typical rate such as 18% and 28% per annum interest. Usually the banks will have a 'minimum payment' amount of around $25 or $30. The problem with paying only the minimum amount is that you will end up paying interest on the balance owing and it will take you 25-40 years to pay off the credit card at the minimum amount that they request you to pay.

I will re-iterate myself because credit cards have been at the root of marital breakdowns, stress, tears and bankruptcies – if you can’t pay them off by the interest free period, don’t use them. Otherwise, you are best off looking at other financing options such as lines of credits or personal loans which charge lower rates of interest.

Debt Consolidation Loans
Debt consolidation is a process whereby you take out a new loan (or increase an existing loan) in order to close off several smaller, separate loans. This can be done by organising a new personal loan, refinancing your mortgage and rolling those debts into your mortgage or withdrawing equity out to pay off your multiple loans.

Why do people consolidate their debts? They consolidate in order to close off the loans with a higher interest rates onto a new loan with a lower interest rate. Credit card debts may be incurring interest at anything between 9% - 38% and by consolidating and refinancing, you replace the debt with a new debt with a lower rate such as 9%. It's also sometimes done to simplify repayments, instead of multiple payments to multiple loans, you make just one single payment for that new consolidated loan.

Margin Loans
Loans that are taken out usually to buy stocks and invest in portfolios. It can also be utilised when trading CFDs. The margin loan is usually secured by your stock portfolio and they will have different loan to valuation ratios (LVR) depending on what stock you buy. The average LVR could be up to a maximum of 70-80%, this varies depending on the lending institution but the higher the LVR, the more you expose yourself to margin calls.

I'll be writing a separate article regarding margin loans due to it's complexity and how it operates.

Mortgage Loans
Mortgage loans are used to buy residential and commercial properties. It's usually for an established amount (eg $380,000) with either a variable or fixed interest rate. Your loan contract will determine the period of the loan (eg: 25 years, 30 years or 40 years) and the monthly repayment amount, which may vary depending on the interest rate charged.

I will be writing articles about how to pay your mortgage off faster, amortisation schedules and techniques to pay your mortgage off faster.

Mortgage offset and redraw facilities
A mortgage offset account works by offsetting your mortgage balance by the amount in your offset account. The interest that is charged is on the net balance amount between these two accounts. To illustrate, assume Sally's mortgage on the 1st of March is $380,000. If Sally has $100,000 in her offset account, then the bank will charge Sally interest on only $280,000.

Lending institutions will usually not approve your loan without a deposit however, they may lend anything from a maximum of 80% to 105% of the property's value depending on your income and repayment abilities. The smaller your deposit and the greater your LVR, you may have to pay lenders mortgage insurance on your loan.

A redraw facility may be a component of your mortgage, depending on whether your mortgage loan has this facility or not (check your mortgage contract). With a redraw facility, if you make any extra repayments then you can withdraw the extra repayment anytime you wish.

Again, this is a complex area and I will write a full article dedicated to mortgage loans. If you don't understand the complexity of a mortgage loan then you will not know what features of the mortgage that you will need. Also, do you really want to be spending the next 30 years of your life paying off your mortgage? Understanding the finer points will allow you to establish the appropriate loan for your circumstance and be flexible enough to cater for your repayment ability.

Overdraft
An overdraft is usually an extension of your normal account, allowing you to have a negative balance. Businesses commonly have overdraft enabled on their account to cater for cash flow imbalances throughout the year. Some individual accounts has overdraft facilities enabled, but be sure to check if you are being penalised for the usage of this facility everytime your account drops below a $0 balance.

Payday Loans
Payday loans are the biggest rort ever. This has got to be the very last resort! The moment you start using payday loans, you are probably closer to insolvency and bankruptcy than you realise. If I could say which loan to avoid at all cost, it would be this one.

Personal Loans
These loans are either secured or unsecured. If the loan is secured, the rate will usually be lower than credit card rates and loans that are unsecured. They usually have a fixed interest rate and a set amount established at the beginning of the loan. The loan will have a payment schedule with fixed repayments, normally monthly, until the loan is paid off. You cannot vary a personal loan without creating a brand new personal loan.

Commonly used for buying cars, consolidating various loans, purchasing white goods, renovation, holidays and multitude of things. Normally classified as a bad debt and not used for investing but for aiding personal spending.

Revolving Line of Credit / Line of Credit Accounts
Similar to an oversized credit card, except they are usually secured. There is an established limit such as $100,000 and you can spend from the line of credit as much and as often as you wish until you have spent your limit – which is $100,000 in this example.

Monthly payments are based only on the component that you’ve used and may vary from a certain percentage to interest only. So if you have a $100,000 line of credit (LOC) and you’ve spent $50,000 on renovation, then you will usually have to pay the interest or minimum percentage on only that $50,000 that you’ve spent. Don’t fool yourself though. You will have to pay that $50,000 principal debt eventually, so be wise and spend only what you can afford.

Store card loans and credit
This basically covers vendor financing. It's where a retail store will offer you their store credit card (eg David Jones or Macy etc). Depending on the terms and conditions, these credit varies markedly. Some whitegood stores selling furniture, for example, may offer a 'buy now, interest free for 2 years' type of deal. If you don't pay the balance off before the interest becomes applicable then they commonly back date the interest charge to the very first date that you bought the goods.

It can be a very expensive lesson to learn. Be wise and if you can't afford to pay for it today, then don't buy it.

Student Loans
These differ from country to country. I’ll only be covering Australian student loans. In Australia they’re called HELP or FSS debts. Which is Higher Education Loan Programme debts.
I'll be writing about HELP debts in depth in a separate article due to it's complexity regarding the discounts that are applicable depending on how you pay the HELP debt.



There are so many type of loans out there. Basically everything and anything could be financed nowadays by the stores or by the shops. The terms and conditions of each loan differs and repayment structures also differ. If you don't understand the loan, don't borrow until you've done your due diligence and understand what you are signing up for.

Paying off your mortgage faster- the scenarios

This particular article of mine is very long and I hope, valuable to you as a reader. It will go into depths with the numbers, figures and examples. If you need to take a break in between, I suggest you do that. I would value a comment feedback if you found this helpful, and if you comment with an outline of your own mortgage structure, that would be interesting.

There are pros and cons of paying off the mortgage faster, however this particular article of mine is only concerned with how to pay off your mortgage faster and what the financial effects are if you pursue various repayment options.

Decades ago, housing was 2-3 times the average annual wage, in modern days, housing is now 5-6 times and more the average annual wage.

Because of this, it’s more important than ever to know how to organize your payments so that you can pay your mortgage off faster, rather than letting the repayments consume the next 25-30 years of your life. Why would the banks advise you how to pay off your mortgage faster? There would be less profit for them if they did that.

If you are using property as a wealth creation vehicle, then this article isn’t strictly appropriate for you. Using property as a vehicle to build wealth, would involve maximizing your investment loans (tax deductible), leverage (LVR) and the amount of properties under your control and it does not necessarily include the goal of paying off your mortgage loans faster.

Paying off any non-deductible debt such as the mortgage on your principal place of residence (PPOR), that is, the home that you live in right now, can be easy by understanding how a mortgage works. You can knock anything from 5-25 years off your mortgage. There are books out there that boast that they paid their mortgage off in 3years. This is possible and achievable if your mortgage isn’t more than 3 times your annual income! Most mortgages though, with the right payment structure setup, can be paid off within 3-10 years.

If you earn $60,000 per annum, and your mortgage is $300,000 then it will take more than 5 years to pay off. Why? $60,000 income, deduct taxes, living expenses, mortgage interest and you can already see that you can’t pay it off in 5 years unless something changes – either you earn more or you spend less. Your target could be to pay it off in 5-10 years. Set reasonable goals and targets.

The ability to pay off your mortgage quickly depends largely on your income but you can learn a few repayment techniques which can help you pay off your mortgage faster, regardless of your income. See my article about “15 Tips on paying off your mortgage faster” filed under the label “All about mortgage loans.”

Once you understand how the loan amortization schedule works, you will be in control of paying your mortgage off faster. I will illustrate a few scenarios and change a few criterias so that you can see the flow on effect of how altering your payments can save you from higher interest charges.

Example:
A few assumptions: Interest rate is variable but will remain unchanged for 30 years for simplicity. I’ve rounded up or down to the nearest dollar. The average loan amount is $300k so I’ll use that for my calculations

Purchase price of house: $375k ($375,000)

20% deposit: $75k
80% mortgage loan amount also known as the principle: $300k
Variable interest rate: 8%
Loan period: 30 years = 360 months
Repayment: Principle + Interest loan
LVR: $300k/375k thus LVR is 80%

Monthly repayment is $2,201 composed of:
Principal: $201
Interest: $2,000

***************

Scenario 1)

You make the same $2,201 payment each month for the next 30 years. No extra repayments. As you can see, your very first mortgage payment, $2,000 goes into the bank’s pocket, and only a measly $201 is applied to reduce your principal loan (the $300,000), leaving you with a loan balance of $299,799

After each month’s payment, you are knocking a further pitiful $1 to $2 or so amount off the principal amount. After one year of paying your mortgage, you feel like you’ve gotten no-where.

You’re absolutely right, you’ve gotten no-where because across that first year, you’ve diligently paid $2,201 each month but out of that - you have paid the bank a whopping $23,909 interest and you’ve knocked only $2,506 off your principle. Leaving your loan balance at $297,494

This is the amortization chart for the first year of your mortgage with this scenario:

Year Month Repayment Interest PrincipalBalance
1 1 2,201.29 2,000.00 201.29 299,798.71
1 2 2,201.29 1,998.66 202.63 299,596.08
1 3 2,201.29 1,997.31 203.98 299,392.10
1 4 2,201.29 1,995.95 205.34 299,186.76
1 5 2,201.29 1,994.58 206.71 298,980.05
1 6 2,201.29 1,993.20 208.09 298,771.96
1 7 2,201.29 1,991.81 209.48 298,562.48
1 8 2,201.29 1,990.42 210.87 298,351.61
1 9 2,201.29 1,989.01 212.28 298,139.33
1 10 2,201.29 1,987.60 213.69 297,925.64
1 11 2,201.29 1,986.17 215.12 297,710.52
1 12 2,201.29 1,984.74 216.55 297,493.97
23,909.45 2506.03

Holy cr@p, you didn’t know you paid that much interest right? You may be one of the few that do know, but there are many people out there, clueless about this breakdown, paying their mortgage, month after month, year after year, and getting frustrated about why they haven’t managed to pay off anything.

Ten years later, you’re still doing the same old monthly payment, month in, month out, blissfully unaware that by the end of the tenth year, you have paid the bank, interest totaling $227,330! And how much principal have you knocked off the loan? Only $36,825! And what’s the balance of your loan to pay? $263,175

The ball is in your court when you reach the 22nd year of your mortgage, after 257 months worth of $2,201/month payments, your interest component is $1,098 and principal component $1,103, leaving your mortgage loan balance at $163,647

Now after 22 years it’s in your favour. It had taken you 22 years to pay off $136,353and the next 8 years to pay off $163,647 in principal.

Why did you suddenly pay off 55% of the loan in the last 8 years and it took you 22 years to pay off 45%?

It’s because the principal component finally exceeded the interest component of your monthly repayments. Finally after 30 years of $2201/month repayments later, you finally paid off your mortgage and you’ve also paid the bank $492,471 in total interest. A total balance of $792,471!

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Scenario 2)

Same amount borrowed (300k), same interest rate (8%) for the same period (30years)
Same repayment amount at $2,201/month

Except in this example, you earned a $2,000 bonus at work the second month into your mortgage and you decide to pay this lump sum into your mortgage to reduce the principal loan by $2000. I will now show you how much that $2000 saved you across the life of the loan.

•You will be mortgage free 9 months earlier
•You will end up paying a total interest of $473,360
•This saves you paying interest of $19,111 across the life of the loan…all this interest saved for just making a lump sum repayment into your mortgage at the beginning of the loan

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Scenario 3)

Same amount borrowed (300k), same interest rate (8%) for the same period (30years)
Same repayment amount at $2,201/month

Except in this example, you earned a $2,000 bonus at work at the end of the third year (36 months) into your mortgage and you decide to pay this lump sum into your mortgage to reduce the principal loan by $2000. I will now show you how much that $2000 saved you across the life of the loan. It will be less of a saving than scenario 2 because the earlier you make the extra repayments, the more interest you save:

•You will be mortgage free 7 months earlier
•You will end up paying a total interest of $477,522
•This saves you paying interest of $14,949 across the life of the loan…all this interest saved for just making a lump sum repayment into your mortgage at the end of the third year of your loan

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Scenario 4)

Same amount borrowed (300k), same interest rate (8%) for the same period (30years)
Same repayment amount at $2,201/month

Except in this example, you earned a $2,000 bonus at work the second month into your mortgage and you decide to pay this lump sum into your mortgage to reduce the principal loan by $2000. Not only that, you decide to give up buying coffee for three days of the week (latte effect) saving you $3 x 3 days x 4 weeks equals $36/month in savings. You can really sacrifice anything you like to come up with the savings. I’m just using a very simple, easy to achieve sacrifice as an example.

Your extra repayments are now $2000 in month two and $36/month until you pay the mortgage off:

•You will be mortgage free 2 years and 6 months earlier!!
•You will end up paying a total interest of $439,204
•This saves you paying interest of $53,267 across the life of the loan

All this interest saved for just making a lump sum repayment early on in our mortgage and the extra small amount of $36 that you were paying every month on top of your regular $2201/month payment.

It’s simple little things like what I’ve hypothesized for you above that makes a huge difference in how you can pay your mortgage off faster and how you can save thousands of dollars in interest. Making extra repayments means that you’ve utilized the power of compounding in your favour rather than letting the bank use compounding in their favour to charge you interest.

You can use mortgage calculators and amortization schedules to do your own scenarios. My intentions are just to demonstrate how a few simple extra payments and how you pay those payments against your home loan, can shorten your loan and also save you thousands of dollars in interest.

15 Tips on paying off your mortgage faster

1)Firstly, have a decent deposit.
20% deposit minimum will save you having to pay lender’s mortgage insurance which is also known as LMI. LMI protects the bank, and not you, if you default on your loan

2)Get a loan with only the features you need at the lowest rate.
It MUST be flexible enough to allow you to make extra repayments, allow redraw and 100% offsets without penalising you

Getting the right loan with the appropriate features in the first place may save you from having to refinance and pay penalties later on. Some loan features to consider are: ability to redraw, make extra repayments, switch between fixed or variable rates, take repayment holidays, offset accounts, line of credit accounts and your loan portability are just a few features.

3)Be wary of “introductory rates”, “honeymoon rates” and “low start” rates.
They typically have lower interest rate for 6-12 months but may not allow additional repayments, thus costing you more in the end.

4)Make your first repayment on settlement date.
Don’t wait for the first payment at the end of the month and this will save you thousands of dollars

5)Pay your purchasing fees upfront and do not capitalize them into your loan.
Fees such as establishment fees, stamp duty fees, legal fees and Lenders Mortgage Insurance fees (LMI). This will save thousands of dollars.

6) Don’t pay your mortgage monthly, but pay it fortnightly.
This ensures you make one extra payment per year which cuts 7 to 8 years off a 30 year mortgage term.

7)Have your salary deposited directly into your mortgage offset account.
That way, the salary is reducing the interest payable from day one.

8)Make extra repayments(consistent or ad-hoc) as often as you can, or make payments that are bigger than the amount required.
EG: if your fortnightly repayment amount is $500, try and pay $600 per fortnight or more if you can afford it.

9)Make sure your extra repayments are deducted from the principle owing, and not recorded as a prepayment of interest.
Check your statements! Contact the bank if this isn’t happening.

10)Interest is calculated daily
So extra repayments made in the early days will reduce your loan principal immediately, reaping a far greater benefit on saving you interest than extra repayments made in the later years

11)Sign up for the professional package.
See your bank to see what they have available. Professional packages can be free or cost up to $400-500 in fees per annum but save you thousands of dollars of interest per annum. It may have features such as a discount on your loan rate, no annual fee credit card, no account or transaction management fees on your account(Eg: CBA Wealth Package)

12)Be careful with the loan amount that you fix the rate on and the fixed term period.
If you’ve fixed too much for too long, this restricts your ability to make extra repayments (usually limited at $10k pa). Or you can be penalized for breaking the loan if you wish to relocate to a new property (portability) and close the loan off. Penalty fees for breaking fixed loans are very exorbitant and can be up to even $40,000 to break.

13)If your bank reduced the loan interest rate, maintain your monthly repayment amount instead of reducing it.
This will ensure you pay off more loan principal because the ratio of interest to principal has changed due to the interest component decreasing. In Australia, banks ordinarily maintain your monthly payments when rates go down (which is a good thing for you!), unless you contact them to change the monthly repayment amounts.

14)Rent out your spare rooms.
Take on some renters and rent those spare rooms out. This could provide you with 300- 1000 per month (for each room) in extra income to pay off your mortgage faster. This can save you thousands, the earlier you do it, the better the results. The bonus is that you don’t even have to work hard for the income. Let your property pay for itself!

15)Check your mortgage contract for any early prepayment penalties and/or deferred establishment fees that may be applicable.
These could cost you up to $700 and more depending on the penalty stipulated on your loan contract. Deferred establishment fees are usually charged when you pay off your loan within 3 or 4 years of the loan start date. This differs between lenders and is usually stated on your loan contract.

Why would anyone pay their mortgage off early when they can invest that extra amount instead?

Roughly, each $1000 you owe on the mortgage, you will end up paying $2,500 to $3000 to the lender in return if you pay according to their required monthly payment amount and do not make any extra repayments.

The earlier you make those extra payments above the required mortgage amount the bank has stipulated for you, the quicker you will pay off your loan and end up saving yourself thousands of dollars, not to mention, you may also be among the rare few to pay off your mortgage loan in less than three years.

Paying off your mortgage quickly may not always be an ideal (or the best) financial goal, but for most people, it’s better to have this as a goal to aim towards than to have no goals at all. Without any financial goals, we trend towards excessive consumption(of crap) and buying too much useless consumer goods. If you can earn more from investing, then it’s always better to invest than to pay off your mortgage early. The challenging part is finding an investment that yields something worthy of your attention.

But I can earn more if I invested the extra amount saved instead of dumping it into my mortgage?
If your mortgage loan rate is 6% pa, each dollar that you pay off your loan principle is in essence, earning 6% pa tax free for you for the life of your mortgage loan, whether that be 1 year or 30 years. That’s equivalent to 6% after tax. If your tax rate was 40%, your investment returns will need to yield at least 10%pa to even justify you not paying off the mortgage with that extra dollar.

Many people are now fearful of the share market and investing in stocks, properties, mutual/managed funds, superannuation and retirement accounts. How could you not feel wary when the market has been as volatile as it has been in 2007, 2008 and 2009? Portfolios and asset values plunged by up to 60% and more. Property values careening below the value of the mortgage loan (particularly in the US) and retirement savings annihilated worldwide.

For these reasons, paying off your mortgage faster is a sure fire way to build equity in your property without as much volatility as investing…not to mention the huge peace of mind that you get, especially if you’re at the retirement(older) end of the spectrum.

I’ve read somewhere that in the US, mortgages are supposedly tax deductible. The problem with tax deductions is that people are so misguided with this feature that they do not try to pay off their mortgages early (so that they can maximize their tax deductions). Instead, the unwise ones will pay only the minimum mortgage amount required and with the funds left over…it’s spent on consumption, keeping up with the joneses and buying flashy cars.

If you can find investments that yield more than the interest charge you pay on your mortgage, go ahead and invest those extra funds. Although, just be sure to adjust the yield rate for taxes before you compare it to your mortgage interest rate.

On that note, I have to say, choose your path and walk your own road.

Using the right type of loan for your spending needs

In a perfect world, you would save up the entire amount before you buy the item, buy the item on your credit card and then pay the credit card balance off before interest is incurred. So basically by your superb account management, you've picked up reward/frequent flyer points which translates to goods and holidays for free (excluding the annual credit card fee that you pay of course).

Unfortunately however, this does not work for many people because they don’t save up the amount before they rush off to buy on the credit card. So when the bills arrive, they scramble around trying to find the money to pay the bills because their income isn't sufficient to pay everything by the due date.

The most important thing I can ever write about how to utilize loans is to match the loan type to your needs. If it’s a long term need, don’t match it with a short term loan or else you’ll be penalized by paying higher interest than you would normally be paying if you had organized the correct loan type in the beginning.

Companies know this. They don’t use a credit card or overdraft to buy a company car, they use leases and car loan financing. They don’t use a credit card or overdraft to fund office renovations. They analyse whether they can afford to buy goods upfront. If they can’t and they really need to buy the goods, then they analyse what type of financing they need, find the best loan type and deal (financing) and then they go and buy the goods.

Most consumers lack this critical research and analysis stage. They want something and they go buy it immediately.

Ordinary folks get into all types of difficulties because of this lack of awareness. If you have no choice but to buy an item that you can’t pay off before the interest free period ends then you shouldn’t be using a credit card. You’re better off using a longer term loan such as a Personal Loan or a Line of Credit to fund your purchase.

DO NOT use a credit card to pay for it. DO NOT use a payday loan to pay for it. In other words, do not use short term loans to buy something that you can’t pay off in the short term. That will be the best advice you ever need regarding loans.