Mortgage Reduction Strategies (1)

Method 1 – Use a 100% Offset Account: http://www.financiallyfree.com.au/mortgage_reduction.htm

The 100% Offset Account method, as well as Method 2 – Using a Home Equity Loan/Line of Credit, use the same principle.

Method 1 still requires you to make your monthly payment and your loan will thereby be reducing over time. Method 2, however, requires a certain amount of discipline and restraint, as you need only make the interest payments.

The principle both methods employ is to funnel all of your income and savings into a facility that will either:

i) “offset” or annul the interest which is charged against a portion of the balance of your loan (method 1); or

ii) directly reduce the loan balance upon which interest is calculated (method 2)

Most people deposit their money into an every day savings account to pay for living expenses, bills, and as a place to store savings. Banks usually only pay in the vicinity of .01% to 3% on such accounts, and you have to pay tax on that.

By putting your money in a 100% Offset account, you will be putting it where it can work the hardest for you by offsetting the interest on your mortgage – tax free!!

Let’s use an example to best illustrate how a 100% Offset Account can slash years off your loan and save you $10′s of thousands of dollars in bank interest.

Heath and Melissa are humble battlers.

• • They both work and have a combined weekly after-tax take home pay of $770 (or $3337 p/mth).

  • They have a $150K mortgage at 6.7% which they have taken out over 25 years.

  • Their mortgage payment is $1032 p/mth, and they share a car so they get by on $400 p/week (or $1734 p/mth) to cover all their living expenses.

They restructure their accounts in the following manner:

1. Instead of having all their income go into a separate savings account, they open a no minimum amount, low/no fee 100% Offset account which they link to their home loan and organise for both their pay-cheques to go into the Offset account. Some providers require that you have a minimum balance of $2000 or so before they apply the Offset so beware and shop around (see: Conclusion).

2. They also apply for a no fee credit card with a $2000 limit (enough to cover their $1734 p/mth living expenses), a minimum 30 day interest free period, and organise with their finance provider to automatically payout the monthly balance of the card from the funds in their offset account at the end of the interest free period. This is known as a “sweep” feature – it’ll avoid you ever having to pay interest on the card balance as you won’t need to remember to pay the card out at the due date every month.

3. They then make most of their monthly purchases using the card instead of using cash.

By structuring their finances this way, they will be having their full combined net salaries of $3337 per month sitting in their offset account for the month until the credit card balance is paid out. This will be effectively reducing the balance of their home loan, upon which interest is calculated daily, by $3337 for the month.

So what difference does this then make over time? Well, assuming they set and monitor their budget so that they don’t spend more than their $400 p/week allocated for living expenses, and assuming they pay all their bills via their credit card, the result will be that they will completely pay out their mortgage in 11yrs and 1mth (not 25 yrs), and will save nearly $100,000 in interest in the process.

Let’s look at the stats:

	Traditional P&I Loan	P & I Loan with Offset Account
Time To Repay Mortgage	25 years	11yrs 1mth
Total Interest Payments to the Bank	$159,547	$63,006
Total Principal Payments Made	$150,000	$74,250
Offset Account Balance	Not Applic.	$75,943*
Total Repayments Made	$309,547	$137,256 + $75,750 (Offset a/c bal.) = Total $213,006
Time Saved	Nil	13yrs 9mths
Interest Saved	Nil	$96,541

* Note: The $75,943 which has accrued in their offset account over 11yrs and 1mth time is calculated by multiplying $571 x 133mths (11yrs 1mth). They are paying their combined salaries of $3337 into this account monthly, and deducting $1032 for their mortgage payment, and $1734 for their monthly living expenses.

$3337 – ($1032+$1734) = $571 p/mth left to accrue in the offset account.

If you don’t like credit cards and choose not to use one, that’s fine – it’ll just take a bit longer to amortise your loan. In the example provided, Heath and Melissa will still be miles ahead by using a 100% Offset account, even if they have to dip into their account during the month to cover expenses.

You should close all your other non-essential savings accounts and use the 100% Offset account to hold all your cash and to conduct all your transactions. You’ll save on fees by not having multiple accounts, and the maximum balance possible will be working in your favour against the mortgage. Finally, make sure it is a TRUE 100% Offset and not one that pays a lower rate of interest to your mortgage – see the article The Different Types of Home Loansfor more detail on this.

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