Pay your loan off faster, be free sooner!

How Do I pay Off My Loan Faster?

Below we discuss some of the most effective methods for paying off your debt sooner and saving thousands of dollars. These techniques save you the most money when applied to mortgages (because mortgages involve larger sums and longer periods of time) however, they can also relate to other debts such as car loans. 

Why Make Bi-weekly Rather Than Monthly Payments?
This is the simplest way to pay your mortgage sooner. Making biweekly mortgage payments rather than monthly payments will reduce the time it takes to pay off your mortgage by several years.

Here is how it works. Let’s say Jan and Tomobtain a mortgage that has monthly payments of $1,000. Instead of paying $1,000 per month, Jan and Tom could alter their mortgage paymentsand make two payments of $500 every two weeks rather than $1,000 per month. There is no issue with the bank as they still get paid the $1,000 minimum every month, and as far as Jan and Tom are concerned, paying $500 every two weeks is almost the same as paying $1,000 per month. Even though this doesn’t feel any different to Jan and Tom, it will shave 5 years and 2 months off of their mortgage and save them over $37,667 over the life of their mortgage (assuming that their interest rate stays the same, and they do not redraw any of those extra repayments).

Here is how Jan and Tom will save so much money.  If they made monthly payments, their bank would debit their account for $1,000 twelve times a year (12 months x $1,000 monthly payments = $12,000 in annual mortgage payments). When they halve their monthly payment and get their bank to pull $500 out of their account every two weeks, they end up making what amounts to one extra monthly payment each year (26 biweekly payments x $500 every two weeks = $13,000 in annual mortgage payments). Most people would never guess that making one extra mortgage payment each year could save them so much money.

As interest is charged daily by most banks an additional saving is achieved by making two payments per calendar month, reducing the principal balance (the sum that the interest payable is calculated on) for a minimum of 14 days each month. When people find out how much money they can save and how many years they can shave off their mortgage, most end up choosing this option. You can even take this method once step further and pay weekly, but it doesn't give you the big savings that biweekly do over monthly payments. Essentially it is just as good, so go with whatever you pay cycle or budget works with, weekly or fortnightly.

What Are Accelerated Mortgage Payments?

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Assuming a mortgage of $300,000 at 5.75% interest over 30 years

Type of Mortgage Payment	Monthly Payment	Accelerated Bi-Weekly Payment	Accelerated Weekly Payment
How it works	This is the payment that your bank or credit union tells you that you must pay each month.	Cut your monthly payment in half and pay that amount every two weeks.	Divide your monthly payment into quarters and pay one quarter of your monthly payment ever week.
Payments	$1,750.72	$875.36	$453.3
Years to pay off mortgage (Amortization)	30 years	24.8 years	24.8 years
Interest saved over the life of the mortgage	$0	$68,163	$68,473

In the above scenario by paying monthly the total repayments accumulate to $630,258.69 to pay off this loan. Having paid the same amountsplit to either fortnightly or weekly payments reduces the total payableto approximately $562,095 representing a saving of more than 10% overall.  An additional $15 payment each week will reduce the loan term by a further 1 year and 9 months.Any additional funds paid will accumulate in a redraw account. These funds can be accessed at any time in the future but by doing so your loan term will drag out and the potential savings will be lost for future. 

Why Round Up My Payments

Round your payment up to the next large number. Paying extra each month will help you get your debt paid off sooner.The amount you pay over and above your minimum monthly payment is applied directly to the principal balanceof your loan. Again, this technique lowers your total loan amount, which in turn reduces the amount of interest you'd be paying on your loans.

Type of Loan	Mortgage
Original Monthly Payment	$960
Rounded Up Payment	$1,000
Reduced life of loan	30 years reduces to 27
Savings over the life of the loan	$20,574

Why Make Extra “Lump-Sum” payments?

When you receive additional income or funds, consider using them to pay down your loan or mortgage. Taking this action will pay you big dividends in the future. Additional funds can be found when you get a bonus at work, receive a tax refund, or luck upon some unexpected money. All extra money that you pay on a loan or mortgage goes straight to paying down your principal balance. As long as your payments are up to date, no part of your extra payment will ever go to interest. This is because your regular monthly payments pay the interest. Anything extra that you pay goes straight to reducing your loan or mortgage balance. This gets your loan paid off sooner and saves on the interest sum you would normally pay the bank.

Why Is The Principal Not Decreasing?

This is best explained by the linear amortization curve. Throughout the life of your loan the percentage of the payments apportioned to interest and principal changes.  Because a larger amount is owed at the beginning of the life of your loan you pay more interest with each payment made. As the debt diminishes more of your payment funds are going toward paying off the principal so the balance reduces faster as time elapses.  As payments remain the same the percentage apportioned to the principal or interest changes over time creating a linear amortization principal and interest curve that is clearly identified on our calculator: http://www.wilsonfinancial.com.au/calculators.html

So don’t be disillusioned, the biggest changes will start to appear one third of the way through your mortgages term, and at the half way mark you really see the balance decrease much quicker.

What Is The Benefit Of A 100% Offset Account?

A 100% Offset account will further reduce your loan term and interest payable on your loan.  An average $10,000 banked in an offset account will provide savings of approximately $560 per year.  This same $10,000 maintained in a standard savings account earning 5% interest will earn $500 but will be taxed at the marginal tax rate of around 30 cents in the dollar so the net return is equal to around $350 per year.  By using an offset account and not ‘earning’ interest but rather ‘saving’ interest you can avoid paying tax unnecessarily and benefit your bottom line by around $260 per year.  Offset accounts provide an extremely useful means of making unused funds work for you and can be just as effective as making extra payments. Discover more in this related article:

http://www.wilsonfinancial.com.au/1/post/2013/01/the-offset-advantage-you-didnt-know-about.html