It's time to rethink the home loan
One of the first steps to buying or refinancing a home loan is to calculate your borrowing capacity.
Most of us will focus on the maximum we can borrow. With record low interest rates, we're seeing Australians stretch their borrowing capacity to the limits in the hope of a better lifestyle.
From a wealth perspective, a bigger debt doesn't create a better lifestyle. It might feel good when you first move in, but a home loan stretched too large can have negative consequences to your personal finances and lifestyle.
How much is too much?
“What is the right amount to borrow for a home?”
For many banks, mortgage brokers or real estate agents, the answer might be"as much as you can!". But this isn't advice, they are just showing how much you can borrow. The choice of how much to borrow is up to you and will depend on many factors.
When it comes to property, emotions can be high and it's difficult to backtrack once you fall in love with a home. We can easily overpay for a property, whenever our emotions become the driver. So how can we do it well?
Reframe the question to:
“How fast can I repay a home loan in the first 4 years?”
Stats show that the first 4 years are critical to making progress on paying down your home loan and positioning yourself to build net wealth over the next 20+ years.
General speaking, when a household makes minimum repayments, the capital owing after four years is similar to what you originally borrowed. This is because a large part of the repayments has gone to paying the interest instead of the principle.
If you started on a 90% LVR and sell your home at the 4 year point, you can find yourself with little or no equity left after you consider sellers fees and stamp duty. If you choose to refinance (which many do), you can be lockIng in paying mainly interest all over again.
Refinancing statistics show us that paying the minimum repayments in the first four years will lead to being stuck with your home loan for 30+ years.
“Without momentum in the first four years, the home loan feels too hard to crack and other goals take place as the priority. From a wealth building perspective, this is where we see things getting messy. It’s easy for people to start 'gambling' with their money in the hope of a quick win. Whether that's extreme tax minimisation, property investing done on a slim cash flow or punting in the stock market. We can become obsessed with what we think will help get us ahead” - Archie Franz, Financial Coach.
But that doesn't have to be you...
Switch your mindset to repaying the loan in 15 years and borrow based on this…
Instead of focusing on how low interest rates are or how much you can borrow... focus on the opportunity you have to make the repayments needed to pay off the loan in 15 years.
Why is this important? Most people do not see that interest rates will inevitably go back up in the near future, and when they do, it's going to hurt.
By thinking different, you can easily save a hundred thousand dollars in interest or more. Let’s take a look at a standard home loan to reveal the difference in wealth over time…
Example Loan:
Property value: $500,000
Borrowing: $450,000 (90% LVR)
Minimum repayments are approx. $468 /week.
Fast forward 4 years... You will pay $50,000 in interest to the bank, but only $48,000 off the principle.
This is where people lose momentum and feel like they havn't made a dint to their loan.
The 4-year mark is where people look to refinance, thinking the problem must be the interest rate.
But the problem is in fact the balance of the loan. Refinancing or consolidating debt locks the interest back in and does NOT help you get the loan paid off quicker. But it does make our banks more profitable!
The key to getting ahead is making repayments that stick.
Add $100 in extra repayments and see what happens:
With the extra repayments, after 4 years you will pay $48,000 in interest and $71,000 in principle. The loan balance will be below $400,000. This is what momentum looks like. You’re breaking the back of the interest, which frees up money to invest later on.
Now see what happens if you increase repayments to +$200 /week...
With the extra $200 in repayments, you can pay off nearly $100,000 in the first 4 years and slash your 30 year loan in half.
The breakthrough point
By focusing on repayments, we free up debt so that we're positioned to start investing while we continue to pay off the home loan.
You don't have to have a 30+ year loan.
Seek wellbeing and financial freedom over a chasing a big home loan.
The information and examples in this article are general in nature, and do no take into account your personal situation.
How can I pay off my home sooner?
Our Financial Advocates can help you build a financial wealth system that gives you financial security. With the right advice and support, you can make great decisions with property and build wealth that lasts.
Book in a free call with our team to talk about your personal situation and aspirations.
