Principal and interest: how to pay off your mortgage faster
Posted on: 16 Aug 2022

Principal and interest: how to pay off your mortgage faster

"Paying off your mortgage in an efficient way can effectively save a lot of interest payments on the home loan." - Bryn Solly, Finance Support Manager

Your mortgage “principal” refers to the amount you’ve borrowed and will need to repay to the lender in time. Paying off your mortgage principal can not only bring you closer to owning your property outright and getting out of debt, but potentially help you pay less in interest charges over time. There are a few home loan features and options that may be able to help you pay off your home loan faster.

 

Book a timeWhy is your loan principal important?

 

Your mortgage principal is another name for the money you owe your lender on your home loan. When your mortgage application is approved, you agree to repay your mortgage principal plus interest charges in regular instalments over the loan term, which is often measured in decades. 

Your home loan’s principal is important because it is used to calculate the interest charges that make up your home loan repayment. The less principal that’s owing on your loan, the less interest you’ll be charged that month (or fortnight, or week).

Your mortgage principal is also used to work out your equity in a property. Your equity is the current value of the property, minus the outstanding mortgage principal. Your equity is how much of your property you own outright, and may be useful when refinancing your home loan, investing in a second property, or accessing a line of credit.

The simplest way to pay off the principal on your mortgage is to make regular principal and interest mortgage repayments. Looking at a breakdown of a home loan’s repayments over time, you may notice that in the beginning the majority of each repayment is made up of interest, with a smaller amount going towards paying off the principal. But over time, the ratio gradually shifts in the other direction, with each repayment paying off more of your remaining principal.

 

While you may have the option to switch to interest-only repayments for a limited time, or to take a temporary repayment holiday, you won’t be paying off your mortgage principal during this time. While these options could provide some financial relief in the short term, you could end up paying more in total interest charges on your property over the long term.

How can you pay off the principal on your mortgage faster?

 

There are a few home loan options available that may be able to help you pay off your mortgage principal quicker and potentially save money on interest charges.

Extra repayments

 

If your lender allows you to make extra repayments onto your home loan in addition to the scheduled repayments, this extra money can go straight towards paying off your mortgage principal. 

Most mortgage lenders charge interest monthly, fortnightly or weekly with your mortgage repayments, interest is often calculated on a daily basis. This means that the more often you can make extra repayments and lower your outstanding mortgage balance, the more you can shrink your interest charges, even if only by a tiny amount at a time. The more you can shrink your interest charges, the more of each home loan repayment can go towards paying off your outstanding principal amount, accelerating your progress towards paying off your mortgage.

Keep in mind that not every home loan will allow unlimited extra repayments – for example, fixed rate home loans are more likely to require you to stick to the repayment schedule, at least during the fixed rate period. Some lenders will cap how much you can make in extra repayments per year, or charge fees for making extra repayments.

It’s also important to remember that using your savings to make extra mortgage repayments means this money won’t be available to you in case of emergencies. However, some lenders offer a redraw facility, which lets you access extra repayments you made previously. While this can put extra cash back in your hands when you need it, it can undo some of the good work reducing your interest charges. Plus, some lenders may put limits on redraws or charge fees to redraw extra repayments.

Offset accounts

 

An offset account is a bank account that’s linked to your home loan. Just like most other bank accounts, you can deposit and withdraw money to and from your offset account as often as you like, and access your money via debit cards, online banking apps, and ATMs.

The difference is that the money you deposit in your offset account is included when calculating the interest charges on your home loan; effectively ‘offsetting’ your mortgage principal.

For example, if you owed $500,000 on your home loan, and had $50,000 saved in your offset account, you’d be charged interest on your home loan as if you only owed $450,000.

An offset account can offer similar benefits to making extra repayments on your home loan, as by lowering your interest charges, more of each home loan repayment can go towards paying off your mortgage principal. And because an offset account otherwise works like a typical bank account, you can easily withdraw money from the account when you need it, giving you some extra financial flexibility.

Is paying off your mortgage faster worth it?

 

While extra repayments, a redraw facility and an offset account can all help you pay less interest, pay off your home loan faster, and benefit from more flexibility around your repayments, it’s important to remember that home loans with more features and benefits may also charge higher interest rates and/or other fees and charges. This means you may not necessarily be financially better off choosing one of these home loan options. 

Before you go signing on the dotted line, it’s important to compare your options, make some calculations, and work out if you’ll get more value from a home loan with extra features, or a more basic “no-frills” home loan with a low rate and no fees.

If you’re not sure which option may best suit your financial situation, or you need help calculating how much value may be offered by these extra features, a mortgage broker may be able to help.

Book a time

Source: RateCity

Bristow, M. (2022, August 9). Principal and interest: How to pay off your mortgage faster. RateCity.com.au. https://www.ratecity.com.au/home-loans/articles/principal-interest-pay-off-mortgage-faster