Are mortgages set up to rob $100,000’s of your cash?

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Are mortgages set up to rob $100,000’s of your cash?

The nation’s largest lender, the Commonwealth Bank, makes a little more than $1.2 million in cash profit every hour, every day. Yep. 24/7 365. It would seem the wealth isn’t so much ‘common’ as it is the ‘bank’s.’

Banks make money by lending it at a greater rate than what they borrow it for. It’s an easy enough system to understand. The profits of banks in Australia, generally speaking, are made by lending money to people who want to purchase a house or investment property. So let’s talk about how the system has been set up to work for the bank and not you, and then find some ways for you to own the property you want but minimise the total amount you pay for it.

For clarity, let’s talk specifically about residential home loans. For a start, you should know the workings of a home loan, but your bank or your mortgage broker haven’t educated you on this. It’s not their fault necessarily, because really, you only asked them if you can afford the dream pad and wanted to know how much it would cost you each month! You’ve been conditioned to believe that you MUST have a loan for 25 or 30 years and that the real important number is the interest rate. Wrong and wrong. You MUST NOT have a loan for anywhere near that long, and the interest rate is definitely not the most important number. With knowledge and discipline you could and should pay off your home in around 15 years. The interest rate is a little red herring. The number you need to know and minimise is total interest paid. We’ll show you how to reduce this amount very soon, but first let’s look deeper into the workings of a principle and interest (P&I) loan.

The bank will calculate the minimum you must pay at each regular payment as determined by duration to maturity (when the loan must be fully repaid). Because the principle is at its highest in the first ten or so years of the loan, the vast majority of the repayment (as kindly calculated by the bank) is going towards—you guessed it—paying interest (their profit). This means the principle stays relatively high for these years and then after year 15 or thereabouts the principle begins to decline, and so, too, finally, does the interest calculated, and your money eventually goes towards paying the principle. Get it? The difference between being in debt for 15 versus 30 years is staggering. For a $600,000 loan at, say, 4%, the difference in interest could be more than $150,000. That’s 25% of the value of the loan!

The banks manage to keep you in the bad debt cycle by employing all sorts of clever sales tricks. They throw credit cards at you, offer you massive limit increases, car and personal loans, and the offer which really gets people; the refinance. The latter is not necessary a bad thing in itself, (although you are resetting the interest time-bomb). Where we see people getting trapped is when the refinance comes with an increase in debt to renovate the kitchen, a pool, holiday, pay school fees, whatever. And here’s the problem: you’re now spending more than you earn, living off your equity, and are being trapped by the banks in a nasty cycle that will in most cases see the bank owning your home for the remainder of your existence. You do get to live there, but the chances are you’ll never actually own it.

But enough with the doom and gloom.

So how to beat the banks? Here’s some advice that sounds really easy to follow, but isn’t. It isn’t, because financial discipline is hard work. If you can’t discipline yourself, you can make it more difficult for yourself to spend by putting some steps in place that will have you thinking twice about spending. For a start, consider the following ideas.
Have everything you earn paid into your offset account, then budget to spend a few hundred less than what your minimum repayment is–every week. Place that extra few hundred into a redraw facility so that you can still access the cash if the sky falls down, but are forced to think more about whether those extra little purchases in the meantime are worthwhile. What we like about redraw facilities is that you can access what you’ve paid over and above the minimum, but you might have to pay a small fee, and it has to be a somewhat larger minimum amount. It’s amazing how suddenly that party frock or gigantic plasma you coveted isn’t worth your hard-earned after all. Financial discipline, people. And by using an offset account every dollar you own is reducing the amount of interest calculated on a daily basis.

Remember, paying more than the minimum amount into the loan is where you pay off more of the principle, which means you’re in debt for less time and pay much less interest to the bank.

IPH exists to help you get ahead financially with simple, proven advice and a few special products and services that will have you financially secure, sooner. We know how the system works and we want to show you how to work the system. If all this sounds pretty good to you, but you don’t have the time to make it happen for yourself, then we’d be happy to help at no cost.

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Tim Jess