How you can benefit from a low rate environment.
Many economists think we’re in for another interest rate cut by the Reserve Bank in 2017.
But rather than worrying about a rate cut – which is unlikely to be passed-on in full to borrowers – mortgage holders should look at the benefits of very low rates.
First, ensure you’re paying the lowest mortgage rate right now.
While an average variable rate is just under 4.0 per cent, there are Australians paying a lot more than that.
So, find the best rate and ask your lender to match it. If they won’t, look at refinancing to a lower cost loan, using a mortgage broker if you need help.
However, be careful about refinancing. Let’s say you have 22 years and $350,000 to go on your 4.5 per cent mortgage. You might be tempted to refinance to a 3.8 per cent loan.
But if you sign-up to a 30-year loan, you end up paying more than if you’d stayed with the 4.5 per cent loan. Your current loan repayments of $2,090 per month mean you’d pay $201,984 in interest over the remaining 22 years.
If you refinanced the $350,000 over 30 years at a rate of 3.8 per cent, you have the lower monthly repayment of $1,630, but you pay $237,106 in interest because of the longer term.
Instead, try sticking with your old monthly repayment amount, and accelerate the repayment of the new loan.
This brings me to the major benefit of very low interest rates: the ability to pay-down principal and speed the loan repayment, before rates rise. In other words, get ahead while the rates are low.
Remember that the interest on the loan principal capitalises in the loan every month. The lower the principal, the less interest you pay.
When you put extra on your repayments (either regularly or as lump sums), you pay down more of the principal, less interest builds up, you can build more equity and you pay-off the loan ahead of schedule.
It’s advantageous for to make extra repayments when the interest rates are low, so there is less principal for future higher interest rates to capitalise on.
You can also make fortnightly repayments (ensuring you pay half of one month each fortnight). This means you make 26 repayments in a year and accelerate by two weeks your paying-down of the principal amount, increasing equity and saving interest.
Some borrowers use offset account mortgages, where all their income goes into an offset account which automatically pays-down the mortgage principal. The household meets weekly costs with credit cards, before being swept monthly.
Accelerated repayments can work with refinancing. Consider the example above: refinance the $350,000 to a 3.8 per cent loan, but maintain your repayments at the $2,090 per month of the original loan.
Now the loan is repaid in under 20 years, with a $50,000 saving on interest.
So leave cash rate predictions to the experts. Your job is to control what you can: pay down the mortgage, reduce the interest bill and increase your equity… before interest rates start to rise.