Regular once off payments to your mortgage may be the key to paying off your home loan early
A lump sum repayment is the term used to describe when you deposit a set amount of money in one go, onto your mortgage or debt. This lump sum repayment is often a once off; where by you decide to pay down your debt with a single deposit when and if you have the extra money.
Lump sum mortgage repayments are smart for two reasons; they have the ability to significantly reduce the term of your mortgage (time) and in turn help you pay less interest (save money).
How a lump sum repayment works to save you money
The amount of interest you pay on your mortgage depends on the daily amount you owe. Most mortgages will calculate interest daily, using the outstanding balance and then charge you fortnightly or monthly (in line with what ever your repayment frequency is) to recover that interest.
So what does this mean? Essentially that the more money you can pay towards your mortgage, the less interest you will pay and the more time you will save.
This is where lump sum repayments come in. Making regular lump sum deposits above and beyond your regular repayment schedule will lead to more money on your mortgage, which means less owing, which means less interest charged.
The trick to lump sum repayments
Now given that lump sum repayments have the ability to help you repay your loan faster; the trick now is to make sure you regularly make lump sum repayments.
For those truly wanting to pay off their loan, every time you see even $1 it can be viewed as a potential lump sum.
Stop thinking about the short term and what that $1 will do for you; putting that money on your mortgage will turn $1 into many more, given the amount of interest you will save.
So what does that mean? It means that when it comes to lump sum repayments on a mortgage, you need to start seeing your money as more powerful. While it depends on your mortgage term and interest rate, I tend to assume every dollar I put on my mortgage is worth three long term.
How much money could a lump sum repayment save you?
Here’s a working example of what a lump sum repayment will do to your mortgage.
You have a mortgage of $500,000 at an interest rate of 7%. Your loan term is 25 years and you are five years into the loan. If for some unforeseen reason you find yourself with $10,000 in cash, whether it be from selling the second car or perhaps withdrawing your long term savings, you decide to make a lump sum repayment.
By adding this money to your mortgage today you will;
- Reduce your mortgage term by 11 months, nearly a full year of your life
- You will save $29,212.06 in interest, that’s the cost of a house deposit.
What makes a lump sum repayment clever
These deposits are simple to make and can be done with any amount of money. Even if you add $100 instead of $10,000, you will still reduce your interest expenses by $300.
It’s like handing someone a $100 note and getting 3x $100 notes back.
Finding the money to make lump sum repayments
Now assuming you are sold on the merits of making regular lump sump repayments, you are now probably wondering how to source the extra funds to make these regular contributions.
The more money you can source; the greater the deposits, savings and time reduction on your mortgage.
Inheritance money. If you find yourself on the receiving end of some money from a family member, why not use it to pay less interest on your mortgage while you figure out a game plan. Many people rush into investments or other ideas when they receive inheritance money; instead simply use it to save money on interest for a while.
The selling of successful investments. Perhaps you purchased some shares many years ago or once regularly made deposits to a managed fund. Sometimes we decide these investments have done their thing and are now ready for the next step. Why not consider depositing the sale of any investments onto your mortgage to materially pay less interest for a while. You may not be earning money with your cash but you are definitely saving money with it.
Selling off assets you no longer need. The second car, the boat, the jet ski; big ticket items similar to this often tie up a heap of cash and upon sale, can make a great lump sum repayment to your mortgage. Consider ridding yourself of excessive assets you no longer need for the future benefit of your finances.
Tax returns. Often we find a nice little surprise and end up with a tax refund come July. Consider depositing this refund straight into the mortgage and letting the tax man do his thing to reduce your mortgage.
Birthday or Christmas money. If a family member gives you money for a birthday or Christmas present; bank it onto the mortgage. Turn the $50 into $150.
Culling expenses, using the savings. Find ways to save money by culling your expenses, getting a better deal on things like insurance and then pocketing the money onto your mortgage on a regular basis. If you find home and contents insurance for $40 less a month; save that $40 onto the mortgage.
Part time work or a second job. Get a side hustle; something you do to make a little extra cash. I used to deliver pizzas at night for a Gourmet Pizza shop, why? Because the tips were amazing and it was flexible. This side hustle would net me a few hundred dollars extra week, tax free.
Create a budget spreadsheet. Start budgeting properly for once. Better understanding your true monthly expenses will help you understand where you are overspending, underspending or if you are indeed living above your means.
The final verdict on lump sum repayments
Remember, interest is the enemy of your mortgage. It’s what stops you progressing forwards; always try to maximise the amount you repay to your loan and always look to add a little extra via lump sum repayments once and a while.
Even $1 could make a massive difference to your situation in 25-30 years.
Question time: how do you source lump sum repayments?
Tell us in the comments below; we would like to know how you go about making or finding extra money to repay your loan quicker.