Rate cuts - make the most of them
THE decision by the Reserve Bank of Australia (RBA) to cut the official cash rate in December is good news for home owners. But as we've seen throughout 2012, most lenders are reluctant to pass on the full value of rate cuts. That makes it essential for home owners to look at other ways to trim their interest bill.
According to comparison site RateCity, following the 0.25% cut to official interest rates in October, lenders reduced home loan rates by anything from 0.04% through to 0.20%. It's likely the same thing will happen this time around though as I write, at least one lender - ING DIRECT, has announced it will pass on the full 0.25% rate cut.
Rather than becoming frustrated by your lender pocketing part of the rate savings, some simple strategies can help home owners enjoy savings of their own.
A sensible starting point is to check how your home loan compares to the broader market. Variable home loan interest rates currently range from about 5.27% to more than 7.0%.
If your mortgage is consistently charging above average interest rates, it could be time to take your business elsewhere. However refinancing is not always as simple as walking down the street to a different lender, and one of the key stumbling blocks can be lenders mortgage insurance (LMI).
LMI applies if you borrow 80% or more of your home's market value. This type of insurance isn't transferrable between lenders so unless you have at least 20% home equity it's likely you'll be slugged with LMI even if you paid it when you first purchased the place.
LMI can take the gloss of savings generated by refinancing. As a guide, if you have a home worth $400,000 and you're refinancing a loan of $360,000, you could be looking at an LMI premium of around $6,400. Check out the online LMI calculator on the website of mortgage insurer Genworth for an idea of the LMI premium you may face.
The thing is, it isn't essential to refinance to save on long term interest costs. The cheapest mortgage is the one you pay off sooner, and making extra repayments is a simple way to enjoy big savings on interest and becoming mortgage-free ahead of schedule.
Making additional payments also helps you build equity in your home, leaving you better placed to refinance further down the track.
Even small extra payments can led to supersized savings over time. Let's say for example that you have a $300,000 mortgage payable over 25 years at 6.5%. The interest cost over the full term would add up to around $307,686. By paying an extra $40 off the loan each month you could cut the long term interest bill by as much as $16,913. That's $2,929 more than the $13,984 you'd save in interest by switching to a loan charging 6.25%.
The bottom line is that it's essential to crunch the numbers before bailing to a different mortgage. And if it turns out you can save on monthly repayments by switching, give your finances an extra boost by using those savings to pay off the new loan sooner.
For more ideas on getting ahead with your home loan, take a look at my book Making Money.
Paul Clitheroe is a founding director of financial planning firm ipac, chairman of the Australian Government Financial Literacy Board and chief commentator for Money magazine. Visit www.paulsmoney.com.au for more information.