We get asked a lot from different clients how the reductions in interest rates will affect their loan and repayments, so I thought in light of the most recent rate reductions and the RBA reducing the Cash Rate down to an all time low of 2.5%, this would be quite timely for many of you.
With a Principal and Interest type loan, typically your bank will not reduce your loan repayment when the interest rates reduce, and generally this is in your best interest. Your repayment typically is calculated at the rate you were on when you took your loan out, over the original term of your loan (which is typically about 30 years). Therefore, as the rates have reduced, the interest you pay on your loan amount will reduce as well. This will mean that the amount of Principal (the amount you pay off your loan) will be more with every repayment, effectively putting you in advance on the loan.
With the cash rate dropping eight times since October 2011 for a total reduction of 2.0% reduced over this time, home owners would have significant savings on their loans, which as a result if they have continued to pay the minimum repayment from October 2011, would put them seriously in advance on their home loan. As an example, if you had a rate of 7.15% in 2011 on a loan of $350,000, your repayment over 30 years would be $2,317 per month. If your current interest rate is 5.15%, and you continued to repay the same repayment, you would be getting in advance on your loan and assuming rates stay the same (a bold assumption to say the least!), you would pay your loan out in less than 21 years. and saving you $122k in interest over the life of the loan.
Now we all know that the interest rates won’t stay this low forever, but by continuing the higher repayments you were making, you will still get significantly ahead and provide you with fantastic savings while it is low, which will ultimately mean that if interest rates do go up higher than what they were when you first took out your loan, you may not even have to increase your repayments at that stage, as you will be so far in advance on your loan.
What about redraw? If I am making greater than minimum repayments does that mean I can redraw the extra funds down the track for renovations or holidays? The answer here is not always straight forward. It depends. Each bank has a different policy and Homeside for instance only accrue redraw if you contact them and reduce the minimum payment, and then continue to pay the higher repayment. Every bank is slightly different with their policy, so if you are unsure just call and we can let you know.
The key thing is that if you have the capacity to pay your original loan amount, keep paying it, as this will really save you significantly while the rates are lower. And if you haven’t reviewed your loan in the last 2 years, now is the perfect time to do so, as there are some great offers on the table at present now that most of the banks seem to be flushed with cash and keen to lend it again. If you would like an objective third party appraisal of your loan to see if your current facility is competitive, we would love to talk to you!