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Michael Pope Blog post by Michael Pope

The Cost of Interest

What is the largest single amount of money you expect to part with in your life?  For most families, a family home will probably be the largest single purchase they will make in their lives.  But while the actual purchase price you pay for a house may be the biggest amount of money you spend in a single lump sum, there is likely to be another cost which, over time, will overshadow even that amount.

Consider someone who buys a $500,000 home using $50,000 of their savings and borrowing $450,000 from a Bank to make up the difference.  Repayments on a 30 year Principal and Interest Loan at an Interest Rate of 7.0% ( ignoring any fees ) would be around $2994 per month, which would add up to a total of over $1 million over the term of the Loan, including nearly $630,000 in Interest  –  more than the original purchase price of the home.  Consider further that if the purchaser was paying Income Tax at the marginal rate of 30 cents in the dollar, they would need to earn over $1.5 million to pay the entire amount of the Loan, of which nearly $900,000 is needed to pay the Interest.

We’re certainly not saying that buying your family home is a bad idea because if the property grows in value by 7% p.a. then in 30 years it will be worth $3.8 million.  However with such a large amount of money at stake, it makes sense to take whatever action you can to minimise the amount of Interest you have to pay, and there are some simple things that can be done to reduce the amount of Interest that you are charged on your borrowings.

The first of course is to borrow money at a low Interest Rate.  This doesn’t simply mean looking around for the lender offering the lowest Interest Rate, but looking for the best combination of features and benefits which meets your needs now and into the future and deciding which Loan represents the best value for money.  When purchasing a new car, you look for a balance between features and benefits (where there are some things that are non-negotiable, some things that are nice to have and some things that don’t matter) and cost (where hopefully you would be considering not just the purchase price, but the whole-of-life cost including running costs, maintenance, repair costs, etc.)  Typically, you would then negotiate with the person selling the car to buy it for the lowest possible price.  When “buying” a Loan, the same processes of comparing value-for-money and seeking to get the best price are just as valid.

By using the services of an experienced Mortgage Broker, you take advantage of their knowledge of the wide range of different Loan products that are available, meaning that they can advise you on the most suitable Loan or Package for your individual circumstances, and they can advise on and take into account features and benefits that you may not even realise are available, or that you might need in the future.

Consider that, if the average person arranges less than a dozen mortgages in their life, and a Mortgage Broker may arrange that many in a week, who is going to have the better knowledge of the products available, and their features, benefits and costs?

Further, because of the number and value of mortgages they arrange on behalf of their clients, a Mortgage Broker may have access to discounts not offered to the general public.  To go back to our analogy of purchasing a car, someone purchasing dozens or hundreds of cars on behalf of a fleet is going to be able to use their purchasing power to get a better price than someone walking in off theL street.

The second important way to save on the cost of Interest charged by a lender is to minimise the outstanding balance.  Most lenders will charge Interest only on the amount you actually owe them (as opposed to the amount you borrowed), so by reducing the amount that you owe, you also reduce the amount of Interest you are charged.  Most lenders will allow you to pay more that the specified minimum monthly repayment on a Mortgage, and I’m sure you’ve heard all the suggestions on the TV or in the newspaper  –  make extra payments, pay a bit extra each month, put that windfall into your Mortgage, pay weekly or fortnightly instead of monthly, etc.  The problem with all these suggestions is that they involve giving your money to the Lender, and it can be difficult (and/or cost money) to get your money back if you need it in the future.

At Empower Wealth, our preferred approach is to use an Offset Account, available from most lenders, which is like a Savings Account, but instead of being paid Interest on your Savings, any balance in this Account offsets the balance outstanding on the associated Loan, and Interest is only charged on the net debt, or the difference between the balance outstanding on the Mortgage and the balance in the Offset Account.  This reduces the amount of Interest payable on the Mortgage, but the money in the Offset Account is yours to do with as you wish, and you can deposit and withdraw money as required.  So instead of earning Savings Account Interest, you are saving Interest on your Mortgage.  Also, while any interest earned on a Savings Account is generally subject to Income Tax, the Interest saved on your Mortgage is not Income, and so is not taxable.  This means that someone paying Income Tax at the marginal rate of 30 cents in the dollar with a Mortgage with an Interest rate of 7.0% would need to find a Savings Account paying 10% per year to get the same net benefit.

In a previous newsletter, we identified that one of the key steps needed to put your Money Plan into action was to get your existing money working as hard as possible for you, and having every dollar earning an effective Interest Rate of 10% is a major step in the right direction.  Empower Wealth’s Personal Wealth Management Program includes recommended Account Structures and money management techniques to enable you to get the best possible return from your money and reduce the amount of Interest that you pay.

If you would be interested in seeing how these tools and techniques could be applied to your own personal financial situation, or would like to learn more about the benefits of having your Loan arranged by an experienced Mortgage Broker, please come and see us for a free one hour consultation by registering at https://ewwebsiteprod.wpengine.com/ or just give us a call.

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