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    Bank Rip-Offs Revealed - Click for Video 

The word Mortgage is actually a concatenation of two French words: the word Mort which means "death", and the word Gage which means "pledge". So in effect, a mortgage is a "death-pledge".

Did you know that the banks will generally structure your home loan so that it takes you 25 years to pay it off? In other words, so that they can milk you for the maximum interest and repayments over the maximum period. It doesn't help when they slog you with overcharges as well (see: Avoid Being Ripped off by your Bank). But it need not be this way.

Reducing the term of your mortgage is quite a straightforward process. By applying a few basic strategies, one can pay off one’s home loan in half the mandated time or less, without making any additional repayments over and above those normally required. How is this possible?

The key principle of Mortgage Reduction is that "Interest is calculated on the daily balance". Therefore, the day-to-day balance of the mortgage account has a significant impact on the interest charged to the loan, and therefore the term of the loan.

There are four basic methods one can employ for Mortgage Reduction. You can use only one of these, or you can use a combination of several of these for maximum benefit. The first two do not require you to pay anymore than your standard repayment, and yet you can halve your loan period. If you don’t use either method no.1 or no.2, then the third requires only a fractionally higher repayment, which you will hardly notice, and yet it will likely shave 6 years and $10’s of thousands in interest off your home loan.

The 4 methods are:

1. Use a 100% Offset Account
2. Use a Home Equity Loan/Line of Credit
3. Make Weekly or Fortnightly repayments instead of monthly
4. Make extra payments when possible (i.e. tax return cheque / Christmas bonus)

The basis behind methods 1 and 2 is to restructure the funding of your property in order to minimise the interest which is charged to your loan.

If you’re a little unfamiliar with the account types we mentioned for methods 1 and 2, see the article The Different Types of Home Loans.

Let’s expand upon the 4 methods.

Method 1 - Use a 100% Offset Account:

We have listed this method as No. 1 as we believe it is the better option for most people.

The reason we believe using a 100% Offset is better is due to human nature. With this method you still need to make your monthly payment and your loan will thereby be reducing over time. Method 2 requires a certain amount of discipline and restraint, and statistics show us that most people, if they have cash to spare, are likely to spend it.

The 100% Offset Account method, as well as Method 2 – Using a Home Equity Loan/Line of Credit, use the same principle.

That principle is to funnel all of your income and savings into a facility that will either:

1. "offset" or annul the interest which is charged against a portion of the balance of your loan (method 1); or

2. directly reduce the loan balance upon which interest is calculated (method 2)

Most people deposit their money into an every day savings account to pay for living expenses, bills, and as a place to store savings. Banks usually only pay in the vicinity of .01% to 3% on such accounts, and you have to pay tax on that.

By putting your money in a 100% Offset account, you will be putting it where it can work the hardest for you, offsetting the interest on your mortgage, and not putting it where the banks want you to put it.

Let’s use an example to best illustrate how a 100% Offset Account can slash years off your loan and save you $10’s of thousands of dollars in bank interest.

Heath and Melissa are humble battlers.

They restructure their accounts in the following manner:

1. Instead of having all their income go into a separate savings account, they open a no minimum amount, low fee 100% Offset account which is linked to their home loan and organise for both their pay-cheques to go into the Offset account. Some providers require that you have a minimum balance of $2000 or so before they apply the Offset so beware and shop around (see: Conclusion).

2. They also apply for a no fee credit card with a $2000 limit (enough to cover their $1734 p/mth living expenses), a 30 day interest free period, and organise with their finance provider to automatically payout the monthly balance of the card from the funds in their offset account at the end of the interest free period. This is known as a "sweep" feature – it’ll avoid you ever having to pay interest on the card balance as you won’t need to remember to pay the card out at the due date every month.

3. They then make most of their monthly purchases using the card instead of using cash.

By structuring their finances this way, they will be having their full combined net salaries of $3337 per month sitting in their offset account for the month until the credit card balance is paid out. This will be effectively reducing the balance of their home loan, upon which interest is calculated daily, by $3337 for the month.

So what difference does this then make over time? Well, assuming they set and monitor their budget so that they don’t spend more than their $400 p/week allocated for living expenses, and assuming they pay all their bills via their credit card, the result will be that they will completely pay out their mortgage in 11yrs and 1mth (not 25 yrs as the bank had wanted), and will save nearly $100,000 in interest in the process.

Let’s look at the stats:

If you don’t like credit cards and choose not to use one, that’s fine – it’ll just take a bit longer to amortise your loan. In the example provided, Heath and Melissa will still be miles ahead by using a 100% Offset account, even if they have to dip into their account during the month to cover expenses.

You should close all your other non-essential savings accounts and use the 100% Offset account to hold all your cash and to conduct all your transactions. You’ll save on fees by not having multiple accounts, and the maximum balance possible will be working in your favour against the mortgage. Finally, make sure it is a TRUE 100% Offset and not one that pays a lower rate of interest to your mortgage – see the article The Different Types of Home Loans for more detail on this.

Method 2 - Use a Home Equity Loan/Line of Credit:

A Home Equity Loan, or Line of Credit as they are commonly referred to, applies the same principle as the 100% Offset account in that it enables every dollar of your income and savings to be used to reduce the mortgage interest.

However, it’s probably fair to say that a Home Equity Loan is only suitable for people who maintain a budget and STICK to it. In other words, those who are very disciplined with their money. There are two key differences with using a Home Equity Loan for mortgage reduction purposes versus using a 100% Offset account:

1. Home Equity Loans are interest only loans and have no term, hence you are not constrained to ever pay it off

2. Your credit limit is normally 80% of the value of your home, which could be hazardous for those who are tempted to stick their hand into the cookie jar

For those who are disciplined, a number of advantages apply to Home Equity Loans:

1. You can consolidate other loans and credit cards which are on a higher rate of interest into the lower rate Home Equity loan

2. They’re generally portable, hence saving you on application fees and establishment costs should you be planning to move house in the future

3. More aggressive or sophisticated home owners could use their equity to invest at a higher rate of return & use the returns to pay off the principal on the debt faster

See the section entitled Home Equity Loan/Line Of Credit in the article The Different Types of Home Loans for more detail on this type of loan.

Putting aside the features and flexibility of these loans as detailed in that article, the example we used for Heath and Melissa in Method 1 would yield essentially the same result if they had used a Home Equity Loan. They would still slash 14 years off their home loan and save nearly $100K on interest.

A final word: if you spend more than you earn, then this is definitely not the option for you. Stick to a 100% Offset account.

It’s best to do a budget first and set a goal as to how much you want to have paid off the loan at the end of each year. Put dates on your plan and work out what the loan balance will have to be at the end of each month in order for you to get there. And finally, and most importantly, after setting up your Home Equity Loan, review your expenditure against your budget plan monthly.

Method 3 - Make Weekly/Fortnightly Payments instead of Monthly:

If you are unable to use a 100% Offset or Home Equity Loan for your Mortgage Reduction, and you are currently making monthly payments, then switch your payments to fortnightly or weekly.

There are two fundamental reasons why weekly or fortnightly is better.

1. Because interest on loan accounts is calculated on the daily balance. As you'll be reducing the balance of the loan more than monthly, you’re creating a slightly lower balance upon which the interest will be calculated. However, the advantage of doing this will be pretty minimal.

2. The main benefit achieved using this method is because you will be tricking yourself into making an additional annual monthly repayment, and the advantage of doing this is quite significant.

You see, if you are making monthly payments, you will be making 12 payments every year. But if you make fortnightly payments, you will not be making 24 annual payments but 26.

However, for this method to be of benefit, you need to set your new fortnightly payment amount at exactly half your current monthly payment.

Beware: if you approach your bank manager and tell him you wish to switch from monthly repayments to fortnightly, he may use the following calculation: (Mthly Pmt x 12) / 26

If you use the bank’s formula, there’ll be virtually no benefit to you and you’ll still be stuck for 25 years making payments to the bank!!

Taking the example of Heath and Melissa (see Method 1 above), the table below shows how many years the use of Method 3 will reduce off their mortgage.

By simply paying 50% of your current monthly repayment fortnightly instead, they will save nearly $32,000 in interest and 4½ years off their loan.

Incidentally, this method proves to be far more effective in high interest rate times, and can slash many more years off your loan, than with the current low rates we are experiencing at present.

Method 4 - Make Additional Payments When Possible:

When you begin paying off a mortgage, the first few year's payments are predominantly made up of interest. In fact, in the first 14 years of a 25 yr P&I loan, you’ll be paying more interest with every payment you make than principal off the loan.

If you can pay a little extra to eat into the principal, then the difference can be significant.

Let’s look again at Heath and Melissa. They may be unable to take advantage of Methods 1 and 2 at present, but have chosen to make use of Method 3. However, they would still like to clear their loan faster than the 20yrs 8mths we came up with in the last example.

Every year in August, they receive a combined tax refund for about $2000, and they have chosen to put this directly towards their home loan every year until the loan is paid out. The table below shows the difference this will make:

By combining methods 3 and 4, Heath and Melissa will now save $66,400 in interest and slash over 9 years off their loan.

Conclusion:

In conclusion, the most important element in all Mortgage Reduction strategies is YOU.

You may derive some benefit by using these methods, but you’ll derive maximum benefit if you set targets, write out a plan and monitor it. Be discerning with your expenditure. We suggest keeping a spreadsheet and writing down all your expenses and reviewing them at the end of the month. Budget and track your spending and you’ll be able to see where the money goes and where you might be able to make additional savings to enable you to get the mortgage monkey off your back that much sooner. Be disciplined – it’ll be worth it.

Here are a few additional tips:

Hidden charges, fees and restrictions usually counterbalance lower advertised interest rates: quite often the lowest interest rate is not the best or most efficient loan.

Speak to your lender about what financial packages they have on offer. By consolidating your banking with one provider, you may be able to get a fee free home loan, offset account, and credit card, as well as discounted home and car insurance. Over a period of years, ploughing the savings you make into your mortgage could make quite a difference.

If you think you might be moving, ensure the home loan you get is "portable". You will thereby avoid discharge costs and establishment fees when you move as you will be able to use the same loan.

If you run a business and you can do it, temporarily park the business cashflow through your Offset account or Home Equity Loan until it is needed. This could reduce your loan interest significantly.

If you’re a professional (teacher, dentist, etc..), look out for "professional" loan packages. You can get a discounted interest rate and bonuses just because the finance providers believe you have stable employment.

Make sure your finances are structured correctly. Some money spent on good financial advice could well be worth it. I used to work with a lady who along with her husband owned an investment property in addition to their home. They were repaying the loan for each property on a principal and interest basis. The problem with this is that the interest on their investment property was tax deductible whereas the interest on their home was not. It would have been far better for them to put the investment property on an interest only loan, and plough the saved principal component into their home loan. They were both in the top tax bracket, so the difference would have been significant.

If you'd like to discuss the possibility of applying the mortgage elimination strategies we have detailed in this article, you can Click here to contact a broker which we have selected and can recommend for this purpose.

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