As the world grapples with COVID-19, interest rates are dropping. While this might not have an immediate effect on some, a low-rate environment presents an opportunity for homeowners who are already paying off a mortgage.
One of the most exciting financial milestones you can hit is owning your own home. But with a mortgage comes great responsibility – the sooner you can pay it off, the better. Building a home loan buffer while interest rates are low is a practical way for borrowers to shave years off their home loans – and protect themselves should their financial circumstances change without warning.
A mortgage buffer is a separate fund for your home loan on top of your monthly repayments. People have traditionally used a buffer to protect themselves from rising interest rates. In the wake of COVID, many are using it to prepare for unforeseen circumstances – like loss of income.
Here’s how you can start a mortgage buffer – and stay on track to pay off your home loan as quickly as you can.
1) Get your calculator out
The first step is to figure out the size of your buffer. Some experts suggest the equivalent of six months of mortgage repayments – but something is better than nothing. You’ll find it’s easier to make the buffer a priority in your budget if you have that magic number.
2) Find a home for your buffer
Next, you need to work out where you’re going to keep your home loan buffer. While it might be tempting to keep the money in a savings account, the best thing to do is link your buffer savings to your home loan. How you do this will depend on your mortgage details.
There are two options:
An offset account reduces your total home loan balance so that the amount you pay interest on is less. It works like a high-interest savings account, and should you need additional cash you can take back funds from it. Just be cautious about constantly withdrawing money.
Here’s how it works:
- Your home loan is $400,000
- You have $20,000 in your offset account
- You’ll only be charged interest on $380,000
- Because you continue to make the same repayment, you pay down more of your loan principal.
A redraw facility allows you to pay extra money directly into your home loan to reduce your mortgage balance – and the interest you’re charged. You can also access these extra repayments if you need to, but leave them untouched and you’ll be able to pay off the principal of your loan faster.
3) Got savings? Add a lump sum
If you have extra money saved and it’s not earmarked for anything, kickstart your home loan buffer by transferring some or all into your offset account or redraw facility. Believe it or not, a few hundred dollars can make a lot of difference.
4) Make extra repayments
The secret to building a home loan buffer? Making regular payments. Any payments will bring down the principal amount of your home loan, so the amount of interest you’re charged over the life of your loan is reduced – saving you money!
For some homeowners, that might mean simply continuing to pay pre-interest-rate-drop minimum monthly repayments, so you’re building a buffer without making any changes. An extra $200 a month on a 30-year home loan of $500,000 at 3% would drop your term by three years.
5) Reassess interest rates
Fixed-term home loan due to rollover? Best time to secure a better interest rate. Yes, a lower interest rate will reduce your minimum monthly repayments – but if you continue to contribute the same amount, you’ll soon build a nice buffer.
Small repayments, profound effect
Most people want to be prepared for whatever comes. Like all financial goals, saving a home loan buffer requires discipline – and that’s why it’s important to speak with a mortgage broker before making any hasty decisions. They’ll be able to determine the best strategy based on your circumstances and spending habits, to set you up for the best financial success.
Reach out to the Global Finance team today to start building a home loan buffer – just in case.
**These are general guidelines and are by no means a reflection of bank or lending policies