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Home loan buffers not for daily expenses

1/11/2010

Home-owners should avoid using any ‘buffer’ they have built up in their home loan as a means to help manage future higher mortgage repayments or other living expenses.

According to Smartline Personal Mortgage Advisers, facilities such as loan redraws and 100% offset accounts are great tools for helping to pay off your home loan sooner, save interest and ‘park’ your savings.

However, Smartline Managing Director Chris Acret said they shouldn’t be used as a vehicle to help manage future higher minimum home loan repayments or other regular household bills.

“Building up a buffer in your home loan – that is making extra repayments above the minimum – is a great strategy, as it is allows you to pay off your home loan sooner and pay less interest on your home loan,” Mr Acret said.

“It’s also a great way to fully maximise the benefits of any spare cash that you might have now but know you will need at some stage in the future.

“However, these facilities – and the money you build up in them – really shouldn’t be used to help cover home loan repayments as rates rise in the future. That’s not what they’re intended for.

“You should never be borrowing to fund living expenses, and that includes drawing back extra you’ve repaid to help ‘top up’ your repayments in the future at a higher interest level.

“At the very least, you should always be covering the interest component, even if you can’t make principal repayments. 

“If you’re concerned about the potential for rising interest rates, then a better strategy would be to perhaps look at fixing at least some of your home loan at a level you can afford, to provide that certainty.

“If you do start to find it difficult to make your repayments, then you’re better off talking with your mortgage adviser about switching to interest only repayments for a period to buy you that ‘breathing space’.

“If you can’t manage your ongoing financial commitments, including your mortgage repayments, then it’s time to restructure your affairs and/or change your lifestyle.”

A redraw facility on your home loan allows you to deposit extra money into the loan, generally in the form of higher ongoing loan repayments, that you can withdraw again when you need it.

Some, but not all, lenders charge a fee to activate the redraw feature and/or a fee each time you redraw, so these costs need to be taken into consideration. As a result, it’s probably best used as a facility to save money for a significant future purchase, such as a new car, holiday or renovations, rather than accessing funds from it on a regular basis.

With an offset account, the balance is offset against your loan. For example, if you have $10,000 in your offset account against your $300,000 mortgage, you actually only pay interest on $290,000. The more money you keep in the offset account, the more interest you save on the loan.

Your offset account can also be used as a savings account for a significant purchase, or is often used by people to ‘park’ funds that they may need to readily access in the future. For example, a couple planning on starting a family in 12 months’ time, which will mean they will reduce to one income for a couple of years, might put as much money as possible in there while both are still working, to access once the baby arrives.

Mr Acret said these loan features provided home-owners with a number of options.

“The thing to remember is that your home loan is always the cheapest form of finance,” he said. “The key is to maximise the flexibility within the home loan as you go through the various stages of life.”

As an example, a couple has a $420,000 loan at 6.71% for 30 years, requiring a minimum repayment of $626 per week.

They decide to cut back on their entertainment budget and pay an extra $100 a week off their home loan, so they are now paying $726 per week. If they continued the higher level of repayment throughout the life of the loan, building this up in their home loan redraw, they will cut nine years and five months off the term and save more than $202,000 in interest.

They then receive a $10,000 windfall and decide to put this in a 100% offset account which stays at that balance for the life of the loan. This would save an extra $28,000 in interest (bringing the total saved to more than $230,000) and take an extra seven months off the term.

With $100 per week in extra repayments and $10,000 in the offset account, after one year there would be $6052 available for redraw and $12,522 after two years.

In two year’s time they decide to go on a $6000 holiday, accessing some of the funds from their redraw. However, in doing so, they reduce the level of interest and time savings on their loan outlined above.

As always, talk to your Smartline Personal Mortgage Adviser for more information.

 

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