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Interest rate cut

So this week the Reserve Bank of Australia (RBA) cut interest rates by 25 basis points to new all time lows of 2.00%. Wooohooooo!!!! This is great news for those of us with mortgages. Provided the banks pass on the full cut, it is expected that the 25bp cut would save around $45 per month on a home loan of $300,000. So the big question is what should you do with the extra cash that you will have post the cut?

  1. Spend it
    This is one option and it is certainly what the Reserve Bank (RBA) would like us all to do. The whole reason the RBA are cutting rates to put more money in our pockets so we will spend it. This helps the economy as roughly 70% of the economy is consumption – you and me spending. The more we spend (up to a certain point) the better the economy goes.
  2. Pay off other debts
    If you have other debts that have high interest rates like credit cards or personal loans then it pays to get rid of these debts as fast as you can. Putting the extra money you gain from the interest rate cut onto your credit card could save you 20% or more (depending on your interest rate) on each $1 of debt paid off, a great return!
  3. Keep your mortgage repayments the same and pay off your mortgage faster
    The benefit of doing this is that not only do you pay off your mortgage faster but when interest rates eventually rise you will be protected as you are already paying off a higher rate anyway. In order for this strategy to work you need to be already managing ok with your mortgage repayment at the higher previous level.
  4. Put the extra into your emergency fund
    An emergency fund helps to deal with any bumps in the road that life might bring like losing your job or unexpected expenses. You should aim to have at least six months of expenses saved. Adding to your emergency fund always helps to build that buffer for when the unexpected occurs.
  5. Consider putting extra money into your superannuation
    Lot’s of factors are important when deciding whether add money to your superannuation. Make sure you get some good financial advice, specific to your circumstances.

So of all the options outlined above Mr Money and I have decided to keep our mortgage repayments the same and reduce our mortgage even faster. Actually, we have decided to do this for this cut and the previous one. I guesstimate (using a mortgage calculator ) that just by keeping our repayments the same amount as prior to the last two cuts we cut around 2 years and 11 months off our mortgage and save us around $20,000 in interest over the life of the loan if interest rates stay at this level. Whoooppppeee!!!

What have you decided to do with your mortgage rate cut?

If you liked this you might also like:

15 Ways To Save Money In 2015

How to Pay Off Your Mortgage Faster

Should I Fix My Mortgage?

How Much Your Credit Card Debt Is Really Costing You

5 Websites That Will Make Or Save You Money

If you would like to read more from me don’t forget to sign up to my weekly email using the form below:



Disclaimer:

The information contained in this post is general in nature and does not constitute financial advice. Please see your financial advisor for advice specific to your individual circumstances.

05/05/2015 5 comments
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fix mortgage

How freakin fabulous would it be to know the future?  I am sure you are the same as me, I did not see coming half the things, both good and bad, that have happened to me.  No one can predict the future.   The same goes for interest rates.  The finance gurus can tell you what they think will happen with interest rates, but when it comes down to it, the reality can be quite different.  However, with interest rates in Australia at historic low levels of 2.5%, it is not an unreasonable to ask “Should I fix my mortgage rate?”   So here are some of the things you need to consider if you are thinking about fixing your mortgage rate.

The biggest benefit of fixing your mortgage rate is that it gives you certainty.  Most likely your mortgage is one of your biggest expenses, with a fixed rate you know exactly what you will be paying month in, month out, during the term of the loan.  But with the benefit of certainty there is a cost and here are the 4 major disadvantages that you need to be aware of when fixing your rate:

  1. Fixed rate loans have a higher interest rate than variable ones.  The key to seeing whether it is worth it, is to figure out, how far interest rates have to rise before paying the fixed rate makes sense.  For example I took a quick look and found a 5 year fixed rate loan at 5.16%.  The variable rate from the same institution was 4.62%.  This means that interest rates would have to increase by more than 54bp for you to ahead on a fix rate loan, let’s call that 3 interest rate rises of 25bp?  Which overall does not seem completely out of the realm of possibility, especially if you are looking over a five year time frame.  Quite often, the difference between fixed and variable rates is much greater than this (say 1.2%) meaning that interest rates have to rise more substantially for you to be ahead.  (Also, remember, as outlined in my post ‘How to pay off your mortgage faster’ it picking the cheapest home loan is not just about the interest rate but you also need to look at the comparison rate.  Click here to see that post.)
  2. Interest rates could fall further and you will miss out on that benefit.
  3. Fixed rate loans often have a ‘break fee’ if you repay the loan early, for example if you sell your house.  This break fee can be very expensive (quite often more than $10,000!), so make sure you are clear on any fees before you decide to fix.
  4. Extra loan repayments are often not allowed when you fix your interest rate or you might be able to do so only after paying a fee.  Also, extra facilities such as an offset account may not be available with a fixed rate mortgage. Click here to learn more about offset accounts.

Nothing is forever and at some point interest rates will start to rise (this not to say that they won’t go lower first).  Everybody should prepare ahead of time and you should stress test your ability to repay your mortgage under higher interest rate levels.  Go to your bank’s website and figure out your repayments after adding a few percent to your rate.  Remember, just five short years ago, mortgage rates were around 9.5%, a big difference to the 5.5%ish most people pay now.  If you are already struggling with your mortgage or you feel you would be if interest rates rise, then fixing might be a great option for you.

Other strategies you could consider include fixing part of your loan and keeping part variable.  This gives you the benefit of both worlds.  Or you if you don’t want to fix you could look to increase your repayments to the fixed rate level, to build a repayment buffer to guard against interest rate rises.  This strategy gives you three benefits: firstly you get the benefits of staying on a variable rate mortgage (such as the ability to make extra repayments); you get used to repayments at higher rates so there is no shock when interest rates rise and lastly you have built a buffer to help protect against rate rises.

Just a quick warning, if you are considering fixing, it is difficult to get the timing exactly right.  This is because the funding for fixed rate loans is different to where banks source the funding for variable rate loans.  This means that fixed rates can move up significantly, long before interest rates actually increase.  Also, it is hard to get the timing right because interest rates might fall further than you expect.  However, if this prospect does not bother you and you prefer certainty then fixing might be an option.

The decision on whether to fix or not to fix is a very individual one.  Personally, we use our offset account quite heavily, so fixing our rate is not the right decision for us, at this time.  However, with rates at historic lows, and the difference between fixed and variable rates being quite small, whether to fix your mortgage rate is a question worth considering.  However, as always, make sure you do your sums and talk to your financial advisor to be sure it is right decision for you.

If you would like to find out more about mortgages please click below to see the following posts:

Home & Contents Insurance: How Do You Know If You Have Enough?

How To Pay Off Your Mortgage Faster

5 Websites That Will Make Or Save You Money

How To Use An Offset Account To Pay Off Your Mortgage Faster

How Interest Rates Impact You And Your Family

* Please note this is for your general information only and does not constitute financial advice.  Please see a financial planner or accountant to get advice specific to your individual needs

03/10/2013 23 comments
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How to Use An Offset Account

For those who missed part one of this series on how to pay off your mortgage faster, please click here.

Ok, now on to the second part of how to pay off your mortgage faster, and this week it is all about how to use an offset account.  Many of you probably have one of these accounts as part of your home loan package, but it never ceases to amaze me how many people don’t really understand how it all works.  Most of the time I think it is because the banks don’t want to explain it to you properly because it is not in their best interests for you to pay off your mortgage early.  They would prefer to charge you the fees for the facility and not have you use it!  So here is my attempt to explain it all fully.

First of all, I have to declare this is one of my most favourite strategies to pay off a mortgage and it is the one my husband and I have used to banish ours.  But be warned, it is not for everybody.  Using an offset account is a strategy that requires oodles of financial discipline.  If this is not you don’t be concerned, just make regular repayments off your mortgage as outlined in part 1.  Easy.  However, if you have solid financial discipline then an offset account can be a great way to turbo-charge your repayment strategy.

So what is an offset account?

An offset account is a transaction account that is linked to your mortgage. The positive balance of your account is offset daily against the money you owe on your home loan.  This reduces the amount of interest you have to pay on your home loan.  For example, if your loan is $400,000 and you have $100,000 in savings, using an offset account will mean you only pay interest on the outstanding home loan balance of $300,000  ($400,000 loan minus the $100,000 savings).  This can cut years off your home loan term.  And remember your savings don’t have to be that big.  Keeping a balance of even $3,000 in the offset will make a difference in the long term.

Ok, so the aim of the game when you use an offset account is to keep as much money as you can in the account to reduce the interest charged on your loan.  This is where the financial discipline comes in.  You see the catch with an offset account is that it is like a normal bank account.  You have access to the money all day, everyday.  So if you can’t handle the temptation to spend, do not use an offset account!!

As the aim of the game is to keep your offset account balance as high as possible it is a great idea to have all your income paid into the account.  Wages, dividends, tax refunds, the lot.  Also, to take the strategy to a new level, many people then use their credit card to pay for their expenses.  This means that your income hits the offset account straight away and reduces your interest bill.  But by using your credit card it means that your costs for the month do not get paid for until the end of the interest free period.  Therefore, keeping the balance on your offset account as high as possible for as long as possible.  The key to using your credit card in this strategy is that you MUST pay off the balance EVERY SINGLE month.  Which is easily organised using an automatic debit through internet banking.  If you cannot pay off your credit card every single month, do not even think of using this part of the strategy as paying 20% interest on your credit card does not make sense to offset a mortgage which is only charging 5% interest.

Other tips for using an offset account:

(1)    Make sure it is a 100% offset account to make sure you are getting the full interest offset on any money you keep in the account.  That is if your interest rate on your home loan is 5% then the money in your offset account will offset the full 5% interest.

(2)    Make sure you link the offset account to your home loan.  Believe it or not you can have an offset but if you do not link it to your mortgage it will not be offsetting anything, regardless of how high your balance is.  Friends of mine had $100,000 in their offset account, only to find that they were being charged full interest on their mortgage because the two accounts were not linked!!!  &*^^%% (insert appropriate swear word here) banks!

(3)    Check how much the fees you are being charged for your offset account are and make sure it is worth it, given your guesstimate of your running balance in the account.

(4)    Offset accounts often come with a higher interest rate to pay for the flexibility.  Check the how much extra interest you might have to pay and make sure it is worth it.

(5)    Using an offset account can be seen as more tax effective than keeping your savings in a bank account.  This is because if you have a savings account with 4% interest and say you are getting charged 37% tax this is equivalent to roughly a 2.5% after tax return.  With the offset you get the benefit of offsetting 5% interest without any tax as you are not earning any interest, as such.  It is the equivalent of a 5% return tax-free.

Using an offset account can be a brilliant strategy to reduce your home loan.  Just be very sure you have the financial discipline to pull it off.  As without financial discipline, this strategy could send you backwards fast.

If you would like to read more from me in 2015 don’t forget to sign up to my weekly email using the form below:



If you liked this post, you might also like:

How To Pay Off Your Mortgage Faster

Home & Contents Insurance: How Do You Know If You Have Enough?

Should I Fix My Mortgage Rate?

How I Saved On My Electricity Bill

5 Websites That Will Help You Make Or Save Money

Winter Family Meals On A Budget

Happy Investing!

 

Money Mummy

* Please note this is for your general information only and does not constitute financial advice.  Please see a financial planner or accountant to get advice specific to your individual needs

10/09/2013 55 comments
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Paying off your mortgage early can be a great investment.  Not only do you get the banks off your back but it frees up cash to be put towards other investments and most importantly it saves you thousands of dollars in interest.  Most people don’t know this but if you let your mortgage run for the full 30 years you will end up paying the banks almost as much in interest as it cost you to buy the house in the first place!!!  You can see why the banks make so much money!!!

In a nutshell, paying off your mortgage quickly is not rocket science, there are only two things you need to do.  Firstly, you need to find the cheapest home loan you can.  Then you need to make as many extra repayments as you can, as quickly as you can.  This two pronged approach means not only is it important to have a mortgage with a low interest rate it is also important to make sure you have the right features as well.

Finding The Cheapest Home Loan

Like everything, the best way to find the cheapest home loan is to shop around.  Comparison sites like Canstar and Money Buddy can give you a good start to find out what is out there.  Speaking to a mortgage broker also might be useful.

The key to finding the cheapest home loan is that it is not just about finding the cheapest interest rate, you need to take into account the fees and charges associated with the loan as well.  This is why you should look at the comparison rate as well as the interest rate.  The comparison rate reflects the actual cost of the loan as it takes into account all the fees and charges as well as the interest payment that you will have to make over the entire life of the loan.  It is rare that the advertised rate and the comparison rate are the same.  So you should look at both, but put more emphasis on the comparison rate as it includes the fees and charges.  There is no point in having a low interest rate if you are getting pinged on fees left, right and centre!  (To find out more about the comparison rate and how it works please click here).

What Are The Best Features To Help Pay Off My Home Loan Quickly?

There are 3 features you should look for in a home loan to help you pay it off quickly:

(1)    Unlimited extra repayments without restrictions or fees.

(2)    Redraw facility – gives you the freedom to access your extra repayments, when life throws you a curve ball and you need access to the money.  Watch out for any fees that may be involved on redraws.

(3)    100% offset account – this account allows you to reduce the amount of interest you pay on your loan by placing money in a savings account linked to that loan.  Make sure it is an 100% offset account to maximise the benefit.  I will explain how this works below.

If you already have an existing loan and want to switch to another loan you should always make very sure that benefits of the switch stack up even after taking into account any fees and charges you might incur for exiting your current loan.  We all know the banks love to sting you with a fee or two when they can, so do your numbers and be doubly sure you are doing the right thing.  Sometimes a better way is to shop around for the deal that suits you best, then ask your current bank to match it in terms of interest rate and features.  Growth in the mortgage market has slowed, so the banks seem more willing to compete and price match in the mortgage market, so this approach is definitely worth a try.  Like my mother always tells me “if you don’t ask you don’t get”!

Strategies For Making Extra Repayments

The power of making extra repayments is huge.  Each extra repayment you make reduces the capital value (principal) of the loan which means that over time you will be paying interest on a smaller amount.  That means your interest bill is growing at a smaller rate and again each repayment knocks off more  principal.  In money terms, just an extra repayment of $100 per month (roughly $25 per week) on an average $400,000 mortgage will cut close to $42,000 off your total interest bill and nearly 3 years off your home loan (using an interest rate of 5%).  Extra repayments can also give you a buffer when, inevitably, interest rates start to rise again.

So here are some great strategies to make extra repayments:

(1)    Move to fortnightly repayments.  This takes advantage of the fact that there are 52 weeks in the year and 12 months.  Fortnightly repayments mean you have made 26 repayments at half monthly repayment rate, or 13 full monthly payments by the end of the year.  The trap with this one is to make sure that you divide your monthly repayment in half and pay that amount.  Some banks get the total yearly interest on your loan and divide by 26, which means that you would pay the same interest for the year regardless of moving to fortnightly repayments.  Complicated!  I agree!

(2)    When the Reserve Bank lowers rates you keep your repayments the same.  This is a great idea if you are living comfortably with your current level of repayments.  This strategy has the added bonus that when interest rates eventually start to rise, it won’t be a problem for you as you have already been paying a higher rate anyway.

(3)    Round up your repayments to a round number.  An extra $6 per month for example,  can cut 2 mortgage repayments off the life of your loan.

(4)    Utilise any lump sum payments you might get as an extra home loan repayment.  Tax refunds, dividends from shares and any work bonuses can make excellent extra repayments.

(5)    Ignore the honeymoon rate.  Some home loans give you a honeymoon rate for a period.  If you ignore this and make repayments at your long term interest rate, it puts you ahead in terms of repayments and means that you won’t be shocked when the honeymoon period ends and your interest rate rises to the ongoing rate.

How To Use A 100% Offset Account To Pay Off Your Mortgage

Now I have to admit this is one of my most favourite strategies to pay off your mortgage and it is the one my husband and I have used to banish our mortgage.  I am constantly surprised at how many people don’t understand how an offset account works and how they can use it to pay down their  mortgage quickly.  Click here to see part 2 of this post, on how to use an offset account to pay of your mortgage.  Or here to learn about the factors you should consider when thinking about fixing your mortgage.

If you liked this post you might also like:

Home & Contents Insurance: How Do You Know If You Have Enough?

Should I Fix My Mortgage Rate?

How To Use An Offset Account To Pay Off Your Mortgage Faster

How To Make Your Savings Work Harder

* Please note this is for your general information only and does not constitute financial advice.  Please see a financial planner or accountant to get advice specific to your individual needs

29/08/2013 41 comments
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How interest rates impact families

Interest rate talk is everywhere, especially with last week’s decision by the Reserve Bank of Australia (RBA) to cut the official interest rate to 2.5%.  Many people think that changes in interest rates impact only those who have a mortgage but this is simply not true.  Changes in interest rates impact everybody.  They influence whether individuals like you and I decide to save or spend or borrow.  Or whether businesses, large and small will expand or contract.  In this way interest rates impact the direction of the whole economy, impacting the daily lives of you and me.

So let’s start at the start – what is an interest rate?  An interest rate is simply the price of money.  The lower interest rates are the cheaper it is to borrow money and spend it and the less attractive it is to save money (because you don’t get much return on your savings).  The converse is true of high interest rates which make it more attractive to save and less attractive to borrow and spend.  Think about it, if interest rates were 15% it is very unlikely that you would want to take out a loan and buy a new house.  However, putting your money in the bank where you would get 15% interest would look pretty attractive.  In this way the RBA uses the level of interest rates to increase the level of spending or saving to make the economy go faster or slower as required.  If the RBA thinks the economy is growing too fast they will raise rates to make it more attractive to save and slow borrowing.  If growth in the economy is slowing then the RBA will cut rates to increase the attractiveness of borrowing and to cut savings.  At the moment the RBA are cutting rates as they are concerned about the economy slowing and so are trying to get us all to save less and spend more.

Things to watch out for in a low interest rate environment:

  1. If you are looking to borrow you must always remember what goes down must go up!  Yes interest rates have gone down recently but when low interest rates do their job and the economy picks up, interest rates will inevitably start to rise.  Don’t be tempted by the current low rates to borrow to the max.  Yes, take advantage of low rates but always stress-test your repayments to make sure that you can still make them at higher levels of interest rates.  For example, when we bought our house back in 2008 (just before the Global Financial Crisis hit), we were paying around 9.5% on our mortgage.  That meant an extra $1,500 on our repayments per month compared to what we are paying now.  A decent chunk of change!!!  Mortgage rates could easily get up to these levels again, so be prepared.  Click here to check out a mortgage calculator to make sure you will be ok when rates start to rise.
  2. Low interest rates are a gift to borrowers – so use it wisely!  The RBA would like you to take the money you save on your mortgage repayments and spend it.  A wiser idea might be to keep your repayments the same so you pay off your mortgage faster (provided you are comfortably making your repayments at current rates).  The latest rate cut reduces repayments by about $50 per month on a $300,000 mortgage.  This seems only small but it can cut years off your mortgage.  Click here to check out a calculator which shows what a difference a small increase in repayments can make over the life of your loan.
  3. Maybe it is time to consider fixing part or all of your home loan.  See my post next week on the pros and cons of such a strategy.
  4. Savers need to make their savings work harder.  If you are a saver, good returns are becoming harder to come by and it becomes more crucial to assess all your options and make sure you are getting the best possible rate for your savings.  Click here to check out my post on what to look out for when choosing an account.
  5. Savers don’t chase returns.  In a low interest rate environment, returns on savings are generally lower and the temptation to take on higher risk investments for greater return grows.  Be very sure you know what you are doing and that you are very comfortable with the increase in risk that comes from higher return investments.  For example, taking money out of cash (low risk) and putting it in shares (higher risk) is a big move up the investment risk spectrum.  Make sure you understand this is what you are doing and you are comfortable.   (Click here to see my post on understanding risk.)

Interest rates are one of the important levers that are used to steer our economy.  Everybody should pay attention to changes in rates as they impact the daily lives of every single one of us.  Interest rates affect whether we borrow, spend or save.  It impacts how easily we find it to get jobs, take holidays or sell our house.  It affects individuals and businesses and nearly every financial decision you make.  Where are rates going from here?  Only time will tell, but I suspect we have seen the last cut for the next few months.  How the economy performs from here will determine which way rates go next.

If you liked this post, you might also like:

How To Pay Off Your Mortgage Faster

10 Easy Ways To Save Money

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* Please note this is for your general information only and does not constitute financial advice.  Please see a financial planner or accountant to get advice specific to your individual needs.

13/08/2013 3 comments
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