Rules of thumb for buying property: Episode three: Settling your home loan
In episode one, we shared the questions you should ask when searching for the ideal property, and in episode two, we shared rules of thumb to consider when for applying for a home loan.
A home bond is one of the cheapest ways to borrow money for most, but it will rack up some serious interest in its average 20 year period. With this in mind, homeowners may be tempted to settle their loan as quickly as possible. However, there is a flipside, which entails missing out on other potential benefits. While the decision to pay off your home loan early depends largely on your personal circumstances and long term goals, here are some key advantages and disadvantages to consider before making this important decision.
Disclaimer
There is more nuance to this situation than meets the eye. For example, you could pay off the majority of your home loan early and then have a small amount that you maintain over a long period of time. This has certain advantages and disadvantages.
The reality is that managing your personal finances in the most effective way possible can be complicated.
If you plan on doing anything above just paying your monthly installment, we strongly recommend that you consult a trusted financial advisor to ensure that this is the best course of action for you.
Advantages of settling your home loan early
Peace of mind
For many people, their home loan is one of their biggest monthly payments and wiping it off their balance sheet is a big relief. Additionally, you can rest easy knowing that you will always have a home, even in tough economic conditions. This is especially important if you are nearing retirement and planning to either live in your home or sell it to downscale.
Save on interest payments
Paying off your loan early means that you will pay less interest over the long term, which usually accumulates to quite a significant amount of savings.
More financial flexibility
Early settlement means that more income can be allocated towards other ventures like personal goals, short term savings or contributions to your retirement account.
Disadvantages of settling your home loan early
Reduced liquidity
You will no longer have immediate access to debt at a low interest rate which could be used for renovating, emergencies or personal cash flow management.
Apply for a new bond if needed
If you want to buy a second property as an investment, or you want to help someone in your family get into the property market, it can become more difficult as time goes on to apply for another loan. Keeping the loan open can be an advantage.
More beneficial use of funds
The money that has been used to pay off a bond is no longer available to be invested elsewhere where it could potentially earn higher rates of return.
Carrying debts that have higher interest rates
As a home loan is typically the cheapest debt available to you, you can save a lot more money in interest by paying off other debt first, such as personal loans or credit cards.
Loss of tax deductions on interest payments
Homeowners who maintain their bond enjoy a tax deduction against rental income on the interest paid. This will be lost when the loan has been paid in full.
Prepayment penalty
You may be liable for bond cancellation fees and may be charged additional interest if you fail to notify your bank 90 days in advance that you are planning to close your home loan account.
Conclusion
It is clear that the answer to the question “Should I settle my home loan early?” is not a simple “yes” or “no”. It is important to examine your financial situation as well as your short and long term goals before you make the decision to settle your loan. Again, it is always prudent to speak to a financial advisor before taking any course of action that could affect your ability to reach financial independence.
