When I was in my early 20s, although I already had a loan (a university loan), I hated the thought of having it or any other loan. I especially hated the thought of paying the banks hundreds of thousands of dollars in interest on the one purchase, and the thought of spending 30 years to pay it off.
If you start to understand what makes a loan so cringeworthy, you can start to unpack how you can make the most out of your home loan; because well, if you’re like me, there’s just no avoiding getting one.
Paying your home loan off faster all boils down to three factors: (1) the amount you borrow; (2) the interest rate applied to a loan; and (3) how long you take to pay it off. These three factors ultimately determine how much you will end up paying to borrow money.
Let’s look at these separately.
1. How does the amount you borrow determine how much you pay to borrow money?
Take an example of two borrowers, everything being equal except the amount they borrow. Borrower A and Borrower B take out a home loan over 30 years with an interest rate of 7%. Borrower A takes out a home loan of $250,000 and Borrower B takes out a home loan of $300,000.
At the end of the 30 years Borrower A who borrowed $250k will have paid $348,722 in interest and Borrower B will have paid $418,527 in interest.
Borrower B ended up paying almost $70,000 more in interest than Borrower A, yet they had the same interest rate (7%) and borrowing time (30 years). The only difference was the amount they borrowed. Borrower B paid $70,000 more in interest, even though they only borrowed an extra $50,000. It all makes a difference.
The more you borrow, the more interest you pay.
2. How do interest rates determine how much you pay to borrow money?
Interest rates also make a difference. Let’s take Borrower A for example who takes out a loan of $300k over 30 years with an interest rate of 7%. At the end of the 30 years Borrower A will have paid over $418,527 in interest.
In contrast, Borrower B takes out the same home loan amount of $300,000 and also over the same term of 30 years; however, with a higher interest rate of 8%. At the end of the 30 years Borrower B will have paid $492,466 in interest.
As you can see, Borrower B ended up paying over $70,000 more in interest than Borrower A, yet they borrowed the same amount of money to start off with; the difference this time was the interest rate.
The higher the interest rate, the more interest you pay.
When you have a loan, it is very easy to forget what interest rate you are paying and to put up with your current rate when better rates are on the market (I am guilty of doing this too).
But the interest rate matters.
Try to schedule a yearly check for interest rates. It’s not hard to do. When we have so many other competing priorities, looking for new interest rates or negotiating a better interest rate just doesn’t get done.
You could schedule your yearly check on the anniversary of purchasing your property, or at the end or start of the year, or maybe you prefer to check around your birthday.
Whenever is convenient for you, try to add this to your yearly schedule so that you can keep on top of interest rate changes and interest rate discounts with other lenders.
3. How does time determine how much you pay to borrow money?
Let’s now consider that both Borrowers A and B take out a home loan of $300,000 with a 7% interest rate, however this time Borrower A takes the loan out for a term of 30 years, and Borrower B takes it out for 25 years.
At the end of 30 years, Borrower A will have paid $418,527 in interest; while Borrower B will have paid $336,102 in interest (plus enjoyed five years of doing whatever they wanted with their earnings).
As you can see, Borrower A paid over $80,000 more in interest than Borrower B even though they borrowed the same amount of money. And the difference was only by five years (even paying your home loan out in 25 years makes a difference in comparison to 30).
Every year less in paying your home loan off is more money that goes back to you.
The longer your home loan, the more interest you pay.
If a new borrower—Borrower C—came along and paid it off in ten years; well, they will have paid $117,990 in interest, saving over $300,000 in interest and having 20 years to use their money in whatever way they please.
If you can pay your home loan off in five years, you really save a lot. For every 1 year less you pay on your home loan, you can save thousands of dollars. To pay it off in five years, you save hundreds of thousands of dollars. Even 10 years can save you hundreds of thousands of dollars.
The longer it takes to pay off your home loan, the more interest you will pay. So get cracking on paying it faster.
Every year when you schedule a time to check on new interest rates, also re-evaluate your home loan and see if you can add an extra hundred dollars or more per month into your home loan to see if you can pay it off even faster.
How to make the most of your home loan?
There are three important points to take from this.
- Get as small a loan as possible to begin with to allow you to pay your loan off faster;
- Try to negotiate the best value interest rate throughout the entire life of your loan (don’t be afraid to continue to negotiate during your loan cycle); and
- Try to pay your home loan off as quickly as possible (every little bit counts).
To understand some of the different types of home loans available, click to view the next blog post.