All the ways to save money on your mortgage

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When you sign up for your first mortgage, the whole thing can seem from the outset as rather set-and-forget. You pick a bank, negotiate a loan and then cross your fingers each month that the RBA opts to crank its big interest rate-lowering lever over in Martin Place.

But inevitably, those pesky bankers and financial advisors start talking about nonsense like redraws and offsets, and what seemed simple can get irritatingly complex. And when it comes to modifying your mortgage, as one reader emailed me to say this week, the whole thing can get a bit muddy.

Mortgages can be a murky business.Credit: Aresna Villanueva

What’s the problem?

Unfortunately, tweaking your mortgage through the use of things such as redraws/offsets can make a massive difference to the amount of money you spend on it, and given it is comfortably one of the most expensive things you’ll shell out for, every little bit counts. Plus, everyone’s doing it: 40 per cent of mortgages in Australia come with offsets, and 70 per cent come with redraws. Do you really want to be the loser who’s missing out?

What you can do about it

So if you want to wrap your head around your options – and find out exactly how they can affect what you pay – read on:

• Redraw v offset: Offered by most banks on most loans, these are two options that can reduce the interest charged on your loan. A redraw account is a feature of a loan that allows you to make additional payments (one-off or repeating) on your loan, sequestering away a stash of money that you can later withdraw. The amount stashed counts towards the total balance of your loan, reducing the interest you pay. Offset accounts work in much the same way, but give you almost unfettered access to your money, as they are essentially separate everyday deposit accounts, linked to your home loan. Though they have different names, mortgage broker Rebecca Jarrett-Dalton from Two Red Shoes says offsets and redraws are very similar, and “have the exact same interest saving function”.

• What do you mean by “reducing interest”? A somewhat common misconception with these offerings is by putting, say, $50,000 into an offset account, your monthly repayments will decrease. In reality, that $50,000 is actually just reducing the interest portion of your loan (what the bank charges you), not the principal (the amount you borrowed from the bank). Take a relatively standard 30-year $500,000 mortgage at an interest rate of 7 per cent: over the course of the loan, a $50,000 offset would save you $257,381 in interest, and cut your repayment time by 6 and a half years. “While the minimum repayment amount does not change, the interest portion reduces because the loan balance interest is calculated on decreases,” says Lindzi Caputo, wealth management director at HLB Mann Judd. “A lower interest component speeds up the repayment of principal.”

• But what if I want to pay less each month? Outside of praying to Michele Bullock for an interest rate cut, your options are limited. If you have some money sitting around, and you’re keen to slice your monthly repayments, Jarrett-Dalton says you can call the bank and ask for a “principal reduction”, where you reduce the limit on your home loan by making a lump sum payment, potentially from your redraw or offset account. “This will reduce your repayments by sacrificing that additional money back to the bank,” she says. “It will no longer be available to you to redraw, and the repayments will be recalculated based on the new maximum loan limit.” This can also be achieved through refinancing, which can sometimes be an easier option as banks can get a bit iffy about principal reductions, and will often try and convince you to put the money into a redraw instead. You could also ask to switch to interest-only repayments, or extend the term of your mortgage, though you will pay more interest in the long term.

• What should I do? Dear reader, this I cannot answer, but I can say that it all depends on your appetite for risk. Making a principal reduction is easier on your hip pocket, but effectively locks away your money, barring refinancing your loan and drawing down on the equity, which is a headache. Redraws won’t change what you pay each month, but they’ll save you money in the long term and allow you to access your stash whenever you want. Caputo notes there’s one more option which could appeal: making additional payments. “Increasing the frequency of repayments from monthly to fortnightly is a good way to get ahead as there are 26 fortnights in a year, allowing for the equivalent of an extra month’s repayment each year,” she says.

Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.