The best loan to repay your debt comes with a few warnings
Record low interest rates have created a clear winner among loan products when it comes to paying down your debt quickly. But there are catches.
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If you want to pay down debt fast, the best loan to use is also potentially one of the most dangerous.
It’s your home loan, and the cost of servicing it has been dropping sharply thanks to three Reserve Bank interest rate cuts since June.
While most lenders haven’t passed on the full 0.75 per cent of RBA rate reductions, their cuts have left mortgage interest rates at the lowest level on record — near 3 per cent.
The RBA’s official cash rate stands at 0.75 per cent.
It’s down from 17.5 per cent less than three decades ago, but can still cause problems for borrowers who don’t use it wisely.
While ultra-low interest rates make now a great time to repay home loans quickly, they also present temptation for people to borrow too much and risk getting stung badly when rates eventually rise.
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Using a mortgage to pay for things such as cars, holidays and other lifestyle desires can push out the time frame to repay those debts to 25 years or more and increase your total interest costs.
For example, a $50,000 car bought using a mortgage can cost more than $43,000 in interest over 25 years if not repaid faster.
If, instead, the car is purchased using a personal loan at a much higher interest rate of 10 per cent but is paid off in five years, the total interest bill is around $16,000.
If you’re folding personal debt into your mortgage, maintain repayments at a much higher rate.
Here’s how it can help.
DEBT CONSOLIDATION
Credit cards are slugging consumers with 20 per cent interest rates that can quickly suck them into a spiral of rising debts.
Consolidating multiple consumer debts into a low-interest home loan can save a pile of interest as long as repayments remain high and the credit cards aren’t reloaded with more debt.
RENOVATIONS
Home improvements can add value to your life and your property.
Just make sure that it doesn’t become a money pit, stacks up financially and that you use qualified, professional tradespeople.
EDUCATION
Parents are digging into their home equity and increasing their mortgages to afford rising school fees.
While this debt doesn’t add any physical assets, there’s a strong argument that a good education is the only thing you can give kids that they can’t throw away, spend or crash.
Going into debt to further your own education can also be valuable.
INVESTMENT
Borrowing to invest has never seemed more attractive.
Rental yields on real estate and dividends paid by shares are both around 5 per cent — much more than mortgage interest costs.
However, it must be a very long-term investment because house prices and share prices can drop sharply.
LIFE EXPERIENCES
Some finance specialists say you should never use your mortgage for buying fun stuff, but I reckon there’s room for flexibility.
If there’s a big expense or experience that means a lot to you — and you have a good plan to repay the debt — go for it.