The mortgage by numbers

MARTIN HAWES

MARTIN HAWES
Last updated 05:00 24/09/2012

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If there was just one thing that you could concentrate on to really improve your wealth, it would be the mortgage.

Reducing your mortgage costs can mean that you save tens of thousands of dollars - an opportunity, almost like no other in finance, to transfer a great deal money from the bank to yourself.

This is because for most of us the mortgage is such a lot of money and is paid for over a great deal of time.

That makes a mortgage expensive: for example, if you take out a mortgage of $300,000 over 25 years at 6%, you would pay the lender a total of $279,871 in interest. When you see a cost like that, you should know that there would be savings to be made. And there are.

The first thing to understand about mortgages is the size of the commitment that you are making when you sign up to it. When you agree to the above mortgage, you are committing yourself to paying interest of $279,871 and also to giving the lender its capital back. Your total commitment is, therefore, to pay $579,871 over 25 years. That is such a commitment that you need to be sure that you are getting the right deal or, if necessary, to take some advice - after all, this is likely to be your greatest financial commitment.

Reducing the cost of a mortgage is best measured by the total amount of interest that you will pay over the course of the loan: that total interest amount of $279, 871 should be firmly in your sights, and you should be doing the numbers to lower that figure.

There are two main things that you can do to reduce the amount of interest that you pay. The first is to get the lowest interest rate possible and, second, to apply as much money as you can to debt reduction. Both of these sound obvious, but as I show below, what may seem a small reduction of the interest rate or a small increase of the payments on the mortgage can make big differences to the total amount of interest you will pay on the loan.

My first example concerns someone who is able to budget better and find an extra $250 per month (a little over $50 per week) that can be applied to the mortgage instead of being spent. If you can make the budget a little tighter so that you can apply $250 per month to the mortgage, your total interest bill falls to $208, 616 - that's an interest saving of $71,255.

The second example is about someone who shops around and/or negotiates hard to get a lower interest rate - they get 5.5 per cent instead of 6 per cent. This is fairly easily done - banks are very negotiable at the moment and if you run your eye down a mortgage rate table you will see plenty of variance between rates. Achieving a rate of 5.5 per cent instead of 6 per cent and assuming that the payments are kept at $1932 per month will mean that total interest will come down to $225,473 (a saving of $54,398).

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These are good but if you put them together you really get some savings.

Assume that house owners not only managed to find an extra $250 per month for the mortgage so that they were able to pay $2182 per month but also hunted around to get that lower interest rate of 5.5 per cent.
Now their total interest is $175,367 - a saving of $104,504.

So, potentially there is over $100,000 on the table for doing two things: first you have to spend less so that you can increase you mortgage payments and, second, you have to be prepared to shop around, switch lenders and negotiate hard.

This is an area where a little eventually becomes a lot (whether small extra payments or small decreases in the interest rate).

This current time of low mortgage interest rates should be considered a golden opportunity for those who are serious about getting ahead: not because they have more money to spend while interest rates are low, but because they can use this time to get rid of big chunks of dead-weight debt. This is a time to keep your monthly mortgage payments up and not be tempted to lower them when interest rates are low.

Martin Hawes is an Authorised Financial Adviser and his disclosure statement is available free of charge at www.martinhawes.com. This article is of a general nature and no substitute for personalised financial advice.

- © Fairfax NZ News

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