Managing your loans and your mortgage
Getting into debt is far easier than getting out of it. If you shop around and manage your loans, they won’t make a mess of your finances.
When should you borrow?
How much should you borrow?
What’s the best loan?
Where to find loans
Which loans should you pay off first?
Why pay loans and mortgages off faster?
When should you borrow?
Look at the total cost including all the interest before you borrow. Only borrow if you are sure you can afford the repayments.
For things you just want, such as a holiday, it’s cheaper to save up for them. For example, Nat and Sam’s $3,000 two-week holiday, paid on their credit cards, took them two years’ hard saving to pay off, and cost them an extra $590 in interest. Even for things you may need, such as a car, it’s cheaper to save if you can.
If you do borrow, pick the shortest repayment period you can afford, especially for anything that you use up quickly, like a holiday, or that loses value, like a car.
For a home, almost everyone has to borrow because it’s hardly realistic to save up for one. In this case, it can make good sense to borrow, because a home could increase in value, perhaps even faster than the interest rate you will pay.
How much should you borrow?
It pays to be cautious. Lenders or mortgage brokers may offer you a bigger loan than you would feel comfortable with. Your lender may increase your credit card limit without asking and without checking if you really can repay higher debt. Interest rates could go up, and if you borrow too much even a small rise could get you into trouble.
| TIP! | Do a trial run before you borrow. Try saving an amount equal to your loan repayments each month, or saving the difference between your rent and home loan repayments (include the one-off costs, such as stamp duty and moving house). |
Could you afford to do that for the full term of the loan, maybe for 20 or 25 years?
You may be overstretching yourself if:
- your home loan repayments cost more than a third of your take home pay, or
- your total loan repayments cost more than half your take home pay.
Use FIDO's Budget Planner to help you decide what home loan you can afford
What’s the best loan?
Usually it’s the loan with the lowest interest rate. This is often the single most important thing to get right, so shop around. Even small differences in interest rates can make a big difference to the total amount you will pay, especially with long-term loans. Extra features that cost you more in interest rates may just waste money.
Look for the ‘comparison rate’ which takes fees into account. ‘Honeymoon’, ‘introductory’ and ‘low start’ loans may sound appealing, but once the honeymoon ends, you could end up in a more expensive loan.
Check that your loan allows you to make extra payments, and if there are any fees for doing so.
Loans with fixed rates may:
- not allow extra payments or, if they do, will commonly limit the amount you can repay over the life of the loan
- charge very high extra fees for paying out the loan early.
Where to find loans
The infochoice.com.au and ratecity.com.au websites are an excellent place to start comparing loans. Magazines and newspaper columns also give a good idea of current rates.
Do consider all types of lenders: credit unions, building societies, banks and non-bank lenders. Loans with the lowest rates of interest may not be the most heavily advertised. Mortgage brokers may be able to help you find out about suitable loans but they may not offer all the low interest home loans available. Read FIDO's tips on using a mortgage broker
Which loans should you pay off first?
Pay at least the minimum amount due to every lender on time. If you can afford extra payments, start with the loan charging the highest interest. Only put extra into other loans once the most expensive one has been paid off. The lowest-priority loan is one that has tax-deductible interest – for an investment property loan, for instance.
Why pay loans and mortgages off faster?
Paying off your loan faster can save you thousands in interest payments.
One simple way to get ahead is to pay your loan fortnightly instead of monthly. In effect, you make the equivalent of 13 monthly payments a year instead of 12. Fortnightly payments will cut four years off a 20-year home loan of $200,000. And if you can pay an extra $100 per fortnight, you will cut seven years off your loan.
If you have some money to spare, consider reducing your loan balance. Paying $1,000 off a credit card charging you 18.5% interest obviously beats putting the same money into a term deposit earning 5.5%. Also, remember the effect of tax. Paying $1,000 off a loan charging interest of 8.9%, saves a full $89. Even if you could invest the money somewhere else that earned $89, you would then have to pay tax.
Be careful about claims that refinancing will pay off your loan faster. You can only pay off loans faster by paying more money. Only refinance if you are sure the savings outweigh the costs:
More about home loans
More about managing your money
More about borrowing and loans
FIDO Website: Printed 11/20/2008
