Home loan debt is biggest contributor to Aussie spending cuts, RBA research finds
Friday 19 July 2019
Record-high mortgage debts are stopping Aussies from spending their money, new research has revealed. A Reserve Bank analysis has found home loans are the biggest culprit behind why we’re pulling back on our expenditure, despite the government’s efforts this month to kickstart our slowing economy with a $158 billion tax cut package.
The analysis found evidence for a ‘debt overhang effect’, where households skimp on spending when there are higher levels of mortgage debt to pay off.
Having 10% more household debt reduced spending by 0.3%, according to the study’s estimates, and this figure didn’t waver even when the value of one’s assets (such as income or house prices) rose to match a growing debt pile.
With Australia’s ratio of household debt to disposable income skyrocketing to an all-time peak of 190%, the ‘debt overhang effect’ could also partly explain why Aussie household spending has been unusually low since the GFC, the study suggested.
But according to Mozo’s banking expert Peter Marshall, Aussies choosing to cut their spending while still shackled to their home loan debt are making a “very sensible” decision.
“They’re doing the right thing for their situation,” Marshall said. “It doesn’t help the broader economy but for their personal situation, absolutely it’s the best thing to do.”
“Housing is still very expensive in Australia, so you have to take out a huge mortgage if you ever want to have a hope of getting a house. The quicker you pay off that home loan, the less interest you’ll have to pay over the life of the loan.”
How to pay off your house sooner
A typical home loan over 25 to 30 years could cost you hundreds of thousands of dollars in interest. So if you took out a $500,000 loan over 30 years and made monthly repayments with an ongoing interest rate of 4.16%*, you could expect to pay back $376,034 in interest (or $876,034 in total) over the life of the loan.
Here are four tips to help you get rid of your mortgage faster, so you can save on interest and boost your finances in the long run:
1. Keep your payments steady
With the recent wave of interest rate cuts, it might be tempting to reduce your home loan repayments and pocket a few more dollars.
However, Marshall suggested keeping those monthly repayments consistent could help: by continuing to allocate, say, an extra $60 to your $500,000 home loan every month, you could finish paying off your mortgage 11 months early and save $13,011 in interest.**
2. Make more frequent repayments
Most home loans default to monthly payments. But CMO of Aussie lender Athena, Natalie Dinsdale, said making a simple switch to fortnightly (or even weekly) repayments can cut down your loan by quite a bit. All you’ll need to do is halve your monthly amount and pay it every two weeks instead of every four weeks - sounds easy enough, right?
“Interest is calculated on your daily balance,” Dinsdale explained. “So the less your balance is each day, the less interest you pay.”
“It’s a great way, without feeling like you have to commit to a whole lot extra, to give yourself a real boost and get the mortgage chopped down a lot quicker,” Marshall added.
3. Every little bit of help counts
As your tax refund for the last financial year flows into your bank account, it’s time to put those dollars back into paying off your home loan debt.
Or if you’re looking to give up on your daily $4 coffee habit, that could mean an additional $56 every fortnight going into home loan repayments.
“Even the smallest extra repayments will make a big dent in your mortgage,” Dinsdale said. “Can you afford to put in an extra $50 a fortnight? It really does make a difference.”
4. Use an offset account
Allocating more money every month or fortnight to paying off your mortgage can be helpful, but MOVE Bank CEO Therese Turner said it’s just as important to consider what interest you’re paying on top of the loan.
“Making extra repayments is one way to pay your mortgage off sooner, but reducing the amount of interest you pay can also help you get ahead more quickly,” Turner said.
“For example, if your home loan has an offset account, you can use this to reduce the total value of the debt used to calculate your interest.”
An offset account is just like an everyday bank account, except it’s linked to your home loan. When you open an offset account, you’ll receive a debit card from your home loan lender, which you can then use to make everyday purchases. You can even deposit your salary into the account.
The main advantage of using an offset account is that your balance will offset daily against the home loan principal, reducing the amount of interest you’ll have to pay. So if you have a $500,000 loan and $30,000 in a 100% offset account, you’ll only be charged interest on $470,000. That means, in a scenario where you’re paying an ongoing 4.16%* interest rate on your home loan over 25 years, you’ll be saving $18,304 in interest, given that you don’t take any money out of the offset account.
“It’s ultimately not as good as reducing the principal on the loan, because as soon as you take the money out the offset, you’re back to paying the full amount of interest again,” Marshall said.
“But if you have chunks of money coming through that are just temporary and you may need to spend on other things later, it can be a really great way to cut down on your interest bills.”
If your mortgage is putting strain on your budget, another great way to save is to switch to a better deal. Check out our home loans comparison table to find the best deals for you.
*Average interest rate of the big banks, as of 18 July 2019
**Calculations based on a 25-year load period with a 4.16% ongoing interest rate