Should I use my savings to pay down my mortgage?

Hi Nicole, wondering what your thoughts are on making extra home loan repayments on our fixed term loan before our 1.89 per cent rate expires in April 2025. We also have a variable term loan. Do we instead pay some more off variable now while rates are high, or keep the money and decrease the loan when we refinance? We have about $100,000 in savings, which is in offset. Someone advised us to just keep the money and take it off our loan when we renegotiate rates. Thanks, Lucy.

Firstly, Lucy, well played on securing that 1.89 per cent rate. I know the coming leap up in interest is probably daunting, but you have saved a fortune the past few years.

While I can understand the intuitive appeal of chunking a bit off your mortgage while the rate is low, there is really no extra benefit in doing so.

It may seem like a good move, but paying off extra on your home loan can sometimes be less beneficial than it seems.Credit: Sam Bennett

When you repay debt, you save the applicable interest rate, which is why it’s usually mathematically better to repay your debts in the order of highest interest rate to lowest interest rate. And yes, all your loan is about to be at a far higher interest rate.

But there is a way to use your $100,000 to save the same amount of interest, without seeing that money subsumed into your loan. To address your options one by one:

Option 1: Paying extra on the fix: Like I said, there is no merit to this that stems from the lower interest rate (except that you’ll shortly be on a higher one and so save that). There are also practical impediments to doing so.

One, you will (usually) be limited in how much you can pay off your fix above the minimum repayments, say, to $10,000 per year. Two, you will (usually) not be allowed to redraw any overpayments made into a fixed rate loan. They will permanently reduce your loan balance, becoming inaccessible to you.

Option 2: Paying extra on the variable portion. Under the loan terms, you would be able to do this … but do you really want to?

While you might be able to get your overpayment out in the future, there’s still no guarantee. Redrawing money paid into a variable loan is at the discretion of the lender. And if you delve into the fine print of your loan, you’ll probably find it can lock the money away from you if you get into financial trouble.

Several lenders in the past have even, controversially, recalculated loan schedules and deemed money borrowers might have just had parked in their loan as part of their loan.

There are also issues with making overpayments directly into a loan if you later decide to convert your property into an investment and upgrade: not only might you not be able to get at money you have sitting in the loan (for, say, a deposit on your new home), if you do, you will lose tax deductions on that amount. And it’s now a ‘poor’ investment property.

Option 3: Keep your money in the offset account. Housing money in an offset account (usually) gives you the identical interest edge as putting money directly in your home loan. The amount in there is netted off your loan balance so you save the interest on that full amount.

Better still, the risks above are removed as the money stays separate and quarantined from your loan itself: you say if/when you want to access it, and it doesn’t actually reduce your loan balance, so full tax deductions if you were to later rent out your property become available too.

An offset account, option three, is the ultimate in flexibility, savings and safety. So, as you were, Lucy. It’s very possible you are already playing this right.

But what to do with your loan next? Because it may be tempting to fix again as some lock-ins are cheaper than variable rate loans right now.

Just bear in mind the reason they are cheaper is because the next rate move is expected to be down. Today, the so-called fixed rate cliff might look steep, Lucy, but consider the risk of interest altitude sickness if you fix again and get stuck way up here at nose-bleed level.

Nicole Pedersen-McKinnon is the author of How to Get Mortgage-Free Like Me, available at www.nicolessmartmoney.com. Follow Nicole on Facebook, X and Instagram.

• 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.

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