Paying off as important as buying
ONE of the best ways to create wealth is to buy your own home and pay it off.
However, the way you pay the house off can make a huge difference to your finances when you come to retirement.
When I was young the conventional wisdom was to focus on getting rid of the home loan before starting an investment program, but there is now a growing awareness that paying your house off at a reasonable rate, and simultaneously starting an investment program is a much better way to go.
Because of the way the mathematics work, the interest rate you pay on a loan does not matter much if the term is relatively short. But, if the term is long the interest rate rises exponentially. For example, if you had a loan of $300,000 at 7% and paid it back over 30 years, the payments would be $1996 a month and you would pay back a staggering $418,000 in interest. Increasing the payments by $1487 a month to $3483 a month will slash the term to just 10 years with interest of just $118,000 - that's a saving of $300,000.
So far so good, but now the loan is down to just 10 years it takes a massive increase in payments to pay it back much faster. Increasing the payments by $2457 from $3483 a month to $5940 would simply take five more years off it and save only another $62,000 in interest.
This is why I regard $12 a thousand a month, that's $2,400 a month on a $200,000 loan as the optimum home loan repayment. This will bring the term to between eight and 11 years if interest rates stay between 5% and 11%.
Noel Whittaker is a director of Whittaker Macnaught Pty Ltd. His advice is general in nature and readers should seek their own professional advice before making any financial decisions. His email is firstname.lastname@example.org.