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.
Showing posts with label Mortgage loans. Show all posts
Showing posts with label Mortgage loans. Show all posts
Thursday, September 3, 2015
Wednesday, April 29, 2015
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.
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.
Monday, October 28, 2013
Saving Up For Your First Mortgage
Are you a home owner yet? Or a property investor? Are you currently neither but are saving up for your first place?
If you haven't bought a property to invest in or live in, then you might be wondering how to and how much to save up for your first property and first mortgage.
Depending on how much you wish to borrow, the idea of borrowing up to hundreds of thousands of dollars can be daunting. Remember, only borrow what you can comfortably afford to repay.
How Much Do You Need To Save Up To Buy A Property?
Property expenses vary depending on the property buy price. Miscellaneous expenses are approximately 5% of the house purchase price.
Some of the common expenses that you'll encounter when buying a property are:
* 5% to 10% deposit on the buy price
* Bank deposit cheque fees (usually used to pay stamp duty, the 5% or 10% deposit and the final deposit amount at settlement)
* Stamp Duty to the OSR which can be from $10k and upwards, approx $40k on a $1m house
* Home and Content Insurance - your lender may require insurance to be organised
* Bank fees for attending settlement
* Adjustment costs for council rates, water/sewerage and water usage
* Legal fees for conveyancing
* Land Titles Office Charge
I've written plenty of posts about how to save money, how to understand loans, saving up for an emergency fund and I've also written plenty of posts on our property buying experience.
So in summary, if you want to save up for your first house and mortgage:
1) Aim to save 5% of the purchase price and that will approximately cover the various fees that you'll have, such as the ones listed above
2) Aim to save at least 20% of the purchase price to use as a deposit so that you won't have to pay lenders mortgage insurance
3) Example: On a $1m house, save $200k for the deposit and save $50k(approximately 5%) for the miscellaneous expenses
I've been looking at Newcastle Permanent's fixed rate loans which are rather competitive. Their two year fixed rate is 4.64%pa. Before you start attending open houses and making offers, ensure that you get a pre-approval organised with your lending financial institution. That way, you know what you can borrow and what you can repay.
Buying a property is really exciting and I wish you all the best in saving up for your first, second or multiple properties.
Thursday, July 25, 2013
To Fix The Mortgage Or Not Fix?
Now that we are thoroughly settled into the house and getting used to the new local amenities, travelling arrangements and so forth, it's time to review our finances again.
With a few mortgage payments already made, there's a little bit of routine happening now. Bills are coming fast and furiously with the multiple investments assets but that's fine because the bad stuff(bills and expenses) is exceeded by the greater positive stuff(investment income).
Currently, mortgage interest rates are at historic lows and looks to be staying that way indefinitely until our economy improves. Particularly the mining industry which is in the doldrums and majorly affecting government tax revenue, thus curtailing the government's spending in relation to social welfare and spending on infrastructure.
To Fix Or Not Fix The Mortgage Rates?
Hamlet(or rather Shakespeare) posed the question, "to be or not to be?" ... although he faced an existential crisis, our crisis is not as dramatic but rather a financial issue.
While interest rates are at record lows, they can be lowered even further. However on the other hand, if the economy improved then the rates would head upwards again to curtail inflation. 50/50 really.
The house mortgage is currently a 100% variable mortgage loan attached with features such as unlimited repayments, ability to redraw, 100% offset facility and the interest is at 5.25%.
If we were to fix, the interest rate would be 4.99% with the option to fix for two or three years. By fixing a portion of the mortgage, that fixed portion would then be stymied by the ability to only make a maximum of $10k in extra repayments per annum and there's probably a limit applicable for redraws(will have to check the terms and conditions), penalties and limits to loan portability, penalties on breaking fixed loans and the offset account will no longer be 100% offset against the fixed loan component.
I've been contemplating on fixing 50% of the loan because I prefer certainty to uncertainty and if interest rates were to drop further, that's okay. BUT if interest rates were to rise then that could possibly hamper our lifestyle somewhat and pose new financial challenges.
Property Planning Australia wrote a short little article which illustrates reasons that are to be considered prior to fixing which I thought was rather useful and may be of help to you if you're facing a similar scenario:
"• Would you like more certainty in knowing what your loan repayments will be?• Do you feel like you are stretched with your cash flow?• Do you have little equity or cash buffer to draw upon if things got tougher?• Are you risk averse?• If rates kept going lower after you fix, would you be comfortable knowing that you cannot access the lower variable rate without a hefty penalty that would almost certainly make it non-beneficial to get out of your higher fixed rate?• Are you confident that you will not sell your house or want to refinance during the fixed rate period?• Do you have non-deductible and deductible debt, and would you feel more comfortable knowing that you had a set repayment for part or all of one or the other?Did You Know That You Can Fix Your Mortgage Loan In Multiple Structures?
If you answer yes to many of these questions, then you are starting to build a case for fixing your debt."
I was thinking about fixing and how it would throw a spanner in the works against making unlimited extra repayments due to the $10k limit on extra repayments...then the question arose, what if we could have multiple fixed portions? That would mean the extra repayments would only be capped by the structure that we've set up. Thought that was too good to be true, however a trip to the bank confirmed that YES it was possible to have several concurrent fixed loan components and each fixed loan component has the facility to accept $10k in extra repayments per annum!
That means that instead of the original structure that I was considering, I could have a better structure that was more flexible. We could even have 5 fixed loan components which would allow $50k in extra repayments per annum in addition to the unlimited extra repayment on the variable portion if we were really that flush with spare funds.
Structure 1:
50% variable at 5.25%, 50% fixed at 4.99% for two years
Thus extra repayments on fixed portion capped at $10k per annum while extra repayments on variable portion is unlimited
Structure 2:
50% variable at 5.25%, 25% fixed at 4.99% for two years and 25% fixed at 4.99% for three years
Thus extra repayments on fixed portions capped at total of $20k per annum while extra repayments on variable portion is unlimited
When I queried the branch manager on why people didn't structure their loan with the greatest flexibility, she replied that not many people knew about structuring and even if you tried explaining or suggesting the structure to them they would get confused, so her work was to help people arrange what they wanted.
As mentioned before in previous posts, I haven't got a crystal ball for the future, however with our current loan, I would like some certainty regarding mortgage repayments. On the other hand, I don't want to limit our ability to make extra repayments so the best option for our scenario is to go ahead with Structure 2 and restructure the mortgage into three parts.
Thursday, October 18, 2012
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.
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
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
Friday, June 24, 2011
Relief that house prices are stabilising
Family and friends all around me have been panicking over the recent years about the lack of housing affordability.
Got a spare $900k anyone? Fancy a mortgage loan of $720k? Got a lazy $180,000 in your back pocket to use as a deposit(down payment)?
House prices were ratcheting up at such a fast rate that we could see housing affordability dwindle before our very eyes. Sure, several of us have bought apartments but less than ten of us have bought a house. We had to start somewhere.
What Do I Mean By 'House' ?
A proper house. At least three bedrooms, bathroom and a carpark on a block that is at least 500sqm and larger. A freestanding house. Not a town house and not an apartment. Not any property that has strata levies to pay.
The property market has settled somewhat due to the increase in the cost of living such as fuel, electricity and mortgage interest rates. It would be a shock if we browsed the real estate websites next year and house prices have yet increased again by $200k or $300k. If it increased $200k in one year, which it has in recent years, that means we would have to save $60k in one single year just to maintain the aim for a 20% deposit.
My latest discussion with family and friends over the topic of buying a home closer to the CBD leads me to conclude that we are all frantically saving in order to buy a house before prices escalate further.
Housing Price Crash Predictions for Sydney
International 'experts' believe that our housing market is overvalued but I challenge them to try and find a rental property. The rental property is tight due to the insufficient number of new housing(apartment+houses) being built and as long as rental yields are decent, investors will keep buying properties and this will support housing prices. It's easy to be an armchair expert sitting at your desk on the other side of the world making predictions about the Australian property market and it's another matter to be pounding the pavement around Sydney, submitting rental applications and being rejected.
Everyone is entitled to their opinions, armchair experts inclusive.
Will our property market collapse like the U.S or the U.K? I think not after looking at these factors. To buy a block of subdivided land cost around $300k. To build a new home on that block is a further $300k. If the price of a house and land package is around $600k then it would be absurd for the D&G(Doomers and Gloomers not Dolce and Gabbana) crowd to think that housing will crash 40% and not find support before that. There would have be high unemployment before investors and owners will start liquidating their properties and the labour/job market in oz right now is tight.
Cheapest House Listed for Sale
In my image above, I've circled suburbs about 30 minutes travel to the CBD. Properties with greater proximity to the CBD will usually be more expensive. I'll be doing a search on www.realestate.com.au and ordering the search results by price, low to high and will post up the CHEAPEST house that is in the search results.
Note that the cheapest house in each suburb are usually on main roads, nowhere near public transport facilities or public transport routes for trains and buses, usually nowhere near amenities such as shops, cafes, schools, on smaller than average size blocks as well, unrenovated, are cottages or fibro, pitiful landscaping and have something glaringly unattractive about them which is why they are the cheapest one in the suburb:
$910,000 at Freshwater
69 Lawrence Street, Freshwater NSW 2096: 3 bedroom, 1 bathroom, 1 car, 423sqm block
$898,000 at Roseville
38 Malvern Avenue, Roseville, NSW 2069: 4 bedrooms, 2 bathrooms, 2 car, 862sqm block
$720,000 at Epping
55 Carlingford Road, Epping, NSW 2121: 3 bedroom, 2 bathroom, 2 carpark
$569,000 at Parramatta
2 Symonds Avenue, Parramatta, NSW 2150: 3 bedrooms, 1 bathroom, 1 car
$600,000 at Kingsgrove
221 Stoney Creek Road, Kingsgrove, NSW 2208: 3 bedrooms, 1 bathroom, 2 cars, 510sqm land
$870,000 at Matraville
81 Jennings Street, Matraville, NSW 2036: 4 bedrooms, 2 bathrooms, 2 car, 632sqm
How was that for a taste of the CHEAPEST house in the suburbs that are at least 30 minutes drive and longer to the city? Dingy, old and unrenovated houses that are poorly positioned and yet still be paying over half a million for them? At least house prices are having a bit of a breather right now and we all need that period of price stability to even have the opportunity to aim for a decent house.
Monday, May 23, 2011
Borrowing $400,000 from the bank
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
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
Saturday, November 20, 2010
Spending everything on the house
Housing in Sydney isn't cheap. Particularly anything within 30km radius of our CBD. We were at a friend's house for her birthday BBQ. Almost all of us aspire to buy a house eventually with the backyard and space so that we can have cats and dogs as pets...and kids too I guess.
The wishlist:
* 3 bedroom (or more) house
* 2 car garage
* 600-700 metre square property - this ensures a backyard
* Within 30km radius of CBD
* Close to shops, public transport (trains + buses), schools and arterial roads (motorways and main roads), parks
* Proximity to the beach would be a dream (this requiring a few millions!!)
* Facing east for morning sun
The reality is that almost all of us live either with our parents, in apartments, town houses or villas. Town houses and villas are more spacious but has no yard. Houses can cost anything between $600,000 to a few millions in the 'desirable suburbs' and the starting points are 2 bedroom houses with no carpark. Or 2 bedrooms, with car park but no yard.
So for anything feasible for an average couple with two cars and planning to have kids, it needs to be at least 3 bedrooms, with car space for two cars and a backyard for the 'potential' kids.
One set of couple, are essentially engaged and they bought an apartment in the Upper North Shore (where the house prices start off from around $1.2 million). Problem is, they said that they spent all their money on the apartment and haven't got enough to buy the rings or get married. This isn't the exception though. Another friend said that she couldn't get married either because they were in the exact same situation.
Their mortgage payments are too much and they can't afford to save up for the wedding.
Mortgage versus diamonds and getting married
With a property, you have a home that you can live in. If they're directing all their spare funds towards their housing mortgage instead of a wedding, it's a form of forced savings. Despite not having much discretionary income left to spare, the savings are at least going towards building housing equity which is ultimately increasing their net wealth. That's a good thing.
The cost of getting married versus paying off the mortgage
Spending $10-$15k, on a diamond ring and then $40-$50k on a wedding is rather insane but that's the average nowadays. To be conservative, if the ring and wedding costs $50k in total, once it's spent, it's gone and it's a sunk cost. If however, you were to use that $50k to pay off the mortgage, you can save hundreds of thousands of dollars in interest savings. I'll illustrate using two scenarios:
Base assumptions: Interest rate of 7.5% fixed for the duration of the loan, 30 year mortgage loan
Example 1: $100,000 mortgage loan
Using the $50k to pay off the mortgage will save you $135,254 in interest over the duration of the loan. Instead of paying $151,721 in mortgage interest, you only pay $16,467 in interest
Example 2: $300,000 mortgage loan (the reality for most Sydneysiders)
Using the $50k to pay off the mortgage loan will save you $245,249 in interest over the duration of the loan. Instead of paying $455,155 in mortgage interest, you only pay $209,906 in interest
So for the average couple in Australia, with the average mortgage of $300,000, spending $50k on their diamond ring+wedding, the cost of marital bliss means paying an extra $245,249 in interest. If you're interested in trickier maths, assuming the couple pays the average 30% tax rate, to earn that $245,249, they need to earn a gross income of $350,355 (before tax).
The wishlist:
* 3 bedroom (or more) house
* 2 car garage
* 600-700 metre square property - this ensures a backyard
* Within 30km radius of CBD
* Close to shops, public transport (trains + buses), schools and arterial roads (motorways and main roads), parks
* Proximity to the beach would be a dream (this requiring a few millions!!)
* Facing east for morning sun
The reality is that almost all of us live either with our parents, in apartments, town houses or villas. Town houses and villas are more spacious but has no yard. Houses can cost anything between $600,000 to a few millions in the 'desirable suburbs' and the starting points are 2 bedroom houses with no carpark. Or 2 bedrooms, with car park but no yard.
So for anything feasible for an average couple with two cars and planning to have kids, it needs to be at least 3 bedrooms, with car space for two cars and a backyard for the 'potential' kids.
One set of couple, are essentially engaged and they bought an apartment in the Upper North Shore (where the house prices start off from around $1.2 million). Problem is, they said that they spent all their money on the apartment and haven't got enough to buy the rings or get married. This isn't the exception though. Another friend said that she couldn't get married either because they were in the exact same situation.
Their mortgage payments are too much and they can't afford to save up for the wedding.
Mortgage versus diamonds and getting married
With a property, you have a home that you can live in. If they're directing all their spare funds towards their housing mortgage instead of a wedding, it's a form of forced savings. Despite not having much discretionary income left to spare, the savings are at least going towards building housing equity which is ultimately increasing their net wealth. That's a good thing.
The cost of getting married versus paying off the mortgage
Spending $10-$15k, on a diamond ring and then $40-$50k on a wedding is rather insane but that's the average nowadays. To be conservative, if the ring and wedding costs $50k in total, once it's spent, it's gone and it's a sunk cost. If however, you were to use that $50k to pay off the mortgage, you can save hundreds of thousands of dollars in interest savings. I'll illustrate using two scenarios:
Base assumptions: Interest rate of 7.5% fixed for the duration of the loan, 30 year mortgage loan
Example 1: $100,000 mortgage loan
Using the $50k to pay off the mortgage will save you $135,254 in interest over the duration of the loan. Instead of paying $151,721 in mortgage interest, you only pay $16,467 in interest
Example 2: $300,000 mortgage loan (the reality for most Sydneysiders)
Using the $50k to pay off the mortgage loan will save you $245,249 in interest over the duration of the loan. Instead of paying $455,155 in mortgage interest, you only pay $209,906 in interest
So for the average couple in Australia, with the average mortgage of $300,000, spending $50k on their diamond ring+wedding, the cost of marital bliss means paying an extra $245,249 in interest. If you're interested in trickier maths, assuming the couple pays the average 30% tax rate, to earn that $245,249, they need to earn a gross income of $350,355 (before tax).
Tuesday, November 2, 2010
Interest rate rises and struggling home owners
Yesterday was Melbourne Cup Day. The horse race that stops our nation. Meaning, the horse race that has our nation betting in some form or other. I bet a massive $2 and won back a massive $6!! Ho Ho Ho!
As for my work colleagues, two of them bet about $300 each and won $4.50 each for their efforts.
Whilst almost everyone in the country was busy gulping down Champagne, platters, lunches and buffets, the Reserve Bank of Australia (let's call them Party Poopers), decided to raise our interest rates by 25 basis points. A 0.25% interest rate hike to 4.75%. The standard variable mortgage rates across Australia are now approximately 7.81% (CBA's rate effective 05/11/10).
Japan and America's rates are ridiculous compared to our rates. Our rates are insanely high compared to the rest of the world. No wonder our dollar is at parity with the US dollar. Foreigners have been exchanging their currencies for Australian Dollars (AUD) so that they can invest their funds in our banks to receive high deposit interest rates of 6% plus.
It would be stupid to not have factored in this rate rise and the next few rate increases. There have been some devasted people posting on the news forum. Electricity, water and gas bills have increased up to 200% over the past two years and wages haven't followed. People are angry and the only ones celebrating are those who are renters and those with funds in savings and term deposit accounts earning paltry interest returns.
The Party Poopers really need to walk into our shopping centres and retail stores to realise how empty some shops are. Sure, our restaurants aren't as empty as those in Japan but a lot of them aren't full either.
As for my work colleagues, two of them bet about $300 each and won $4.50 each for their efforts.
Whilst almost everyone in the country was busy gulping down Champagne, platters, lunches and buffets, the Reserve Bank of Australia (let's call them Party Poopers), decided to raise our interest rates by 25 basis points. A 0.25% interest rate hike to 4.75%. The standard variable mortgage rates across Australia are now approximately 7.81% (CBA's rate effective 05/11/10).
Japan and America's rates are ridiculous compared to our rates. Our rates are insanely high compared to the rest of the world. No wonder our dollar is at parity with the US dollar. Foreigners have been exchanging their currencies for Australian Dollars (AUD) so that they can invest their funds in our banks to receive high deposit interest rates of 6% plus.
It would be stupid to not have factored in this rate rise and the next few rate increases. There have been some devasted people posting on the news forum. Electricity, water and gas bills have increased up to 200% over the past two years and wages haven't followed. People are angry and the only ones celebrating are those who are renters and those with funds in savings and term deposit accounts earning paltry interest returns.
The Party Poopers really need to walk into our shopping centres and retail stores to realise how empty some shops are. Sure, our restaurants aren't as empty as those in Japan but a lot of them aren't full either.
Thursday, October 22, 2009
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.
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.
Thursday, October 8, 2009
Stuck on a hamster wheel running round and round?
Life is bit like that. We are always so busy working and running around. But if you stop to take a look, did the world change and you haven’t changed with it?
You may find yourself thinking after a few years of working…have you really achieved anything? You’ve found your partner, had your kids, did the obligatory thing and sold your apartment to buy a house so that you could have children. Then when the house got crowded, you sold that one and upgraded to a bigger one with a bigger mortgage.
Now you find yourself working harder than ever and wondering what happened and how did you find yourself working like a dog 9-5 or even longer hours than that. And yet, your mortgage is bigger than ever, time is passing furiously and you’ve got stacks of bills to pay, a family to look after and the thought of retirement is scaring you because you know you need to start saving for retirement but how can you when there’s just nothing left at the end of the month?
This is probably one of the most common situation people find themselves in, because they’ve taken the common route in life. Go to school, go to university/college, study hard, get a job, get married, buy a place to stay, have some kids, sell the small place and upgrade to a bigger house, pay the mortgage for 25-30 years, retire and then die.
Sometimes it’s not perfect. That is, you can’t find a partner, you don’t have kids, you married but then you divorced, you divorced and remarried with stepchildren, you can’t afford to buy any property at all, you didn’t study etc
The problem with life is that it demands us to know what we want to do when we’re 18 years old and by the time we’re in our twenties or thirties, we have a ghastly suspicion that we may be working in the wrong job or not doing something that we really want to do such as philanthropic work, starting your own business or contributing more to society.
If you have not had kids yet, you should be saving as much as possible while you still can. When you have kids, you will find yourself with many more expenses than ever before and find saving anything a very difficult thing to do.
We’re all on the hamster wheel to some extent. When we were students, we earned very little, but our expenses were also low. As you get older, you typically (hopefully) earn more, but as the income increases, you will find your expenses grow to match the income. How? You end up spending more, buying more, eating out more, living more lavishly, renting a bigger apartment, buying a bigger house.
With expenses increasing as your income increases, there’s not really much left over to save and invest. So you can find yourself on a hamster wheel, running harder than ever, but going around in circles.
Once of the biggest problem I’ve noticed happening with a lot of couples, is that they have kids and then they buy a bigger house. Their mortgage is so big (we’re talking $400,000 to $800,000) that all they do is just barely scrape through with the monthly mortgage repayments. The problem with just barely making the mortgage payments means there is not much left over to make extra repayments. If you read my articles under the “All about mortgage loans” label, then you will see how devastating the effect is when you can’t make extra repayments.
If your mortgage loan is $300k, interest is 8%, the term is 30 years and you make the required monthly repayments of $2201…. You are slaving at work to pay the bank about $2000/month and only knock about $201 off the loan principle…you are in effect, building up your equity and net wealth by only a measly $201/ month. Of course, the ratio changes as you progress through the months and your property may rise in value(capital appreciation) but the amount that borrowers pay in mortgage interest is one of the secret destroyers of wealth. Particularly when it’s a loan on a home they live in and the interest is not tax deductible.
The best time for any of this self realization to occur is in our twenties, and if you’re past your twenties, then the best time is today. By starting today, we’ve got time to take note of how far we’ve come, where we would like to go, and then make plans on how we achieve that. You can be happier.
Whenever you feel that you’re on a hamster wheel going round and round, all you have to do is get off it. Take a step back, do a bit of meditation or contemplation, take a day off or find some ‘alone’ time with yourself to evaluate your life and the directions you would like to head towards. Write it all down so that you can take the weight off your mind.
It’s all about reconciling our inner dreams and desires with our practical reality. The reality of life is that things aren’t handed to us on a platter. If we want any dreams to come true, we have to figure out a way to achieve it. It’s just like when you were younger, you believed in the tooth fairy (which is the dream) and your parents made it come true (which is the reality). When you grow up though, you are now the adult or the parent and you will have to create your own reality.
Wednesday, October 7, 2009
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!
***************
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
***************
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
***************
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.
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!
***************
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
***************
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
***************
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.
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