As all homeowners with mortgages know, interest rates have soared over the past 18 months. Back in August 2021, the average one-year fixed rate for owner-occupiers on Canstar’s mortgage database was 2.58%. Now, at time of writing, it’s more than double that figure.
As a result, home loan repayments for those refixing their mortgages in the new higher rate environment have risen by around 50%, which can require some pretty serious budgeting.
So if you’re facing a precipitous rise in the costs of servicing your mortgage, Canstar explores simple steps you can take to help reduce your home loan repayments.
Extend term of mortgage
A quick and simple way to reduce your mortgage repayments is to extend the term of your mortgage. If you’ve 20 years left on the term of your loan, you could refinance it over 25 years, for example.
However, while it can save you money in the short term, those extra five years can cost you a huge amount in extra interest repayments. On a $500,000 loan, at the current average 1-year fixed rate on Canstar’s database of 6.66%, the numbers look like this:
|Loan amount||Loan term||Monthly repayment||Total interest on loan|
|$500k @ 6.66%||20 years||$3775||$406,027|
|$500k @ 6.66%||25 years||$3426||$527,858|
As you can see, while you would save $349 on the cost of your monthly repayments (a 9% reduction), those extra five years would result in you paying $121,831 more in interest charges (30% extra).
So while extending your loan term can deliver a quick, short-term reduction in your household expenditure, ultimately, it will prove very expensive.
Switch to an interest-only home loan
Switching to an interest-only loan is another way to reduce your monthly mortgage repayments. But, once again, it is only a short-term solution.
As its name suggests, an interest-only home loan involves paying only the interest charges on the loan, and not paying down the principal loan amount.
Using our example of a $500,000 loan at 6.66%, going interest only would involve a monthly repayment of $2775. However, regardless of how long you paid that monthly amount, your debt would never reduce.
This is why interest-only loans are usually favoured by property investors, and those aiming to make capital gains through property speculation.
Change your repayment frequency
If you’ve got a mortgage, you’ve probably heard the advice that paying it off in more regular instalments will save you money. The idea is that you’ll pay your loan off faster, as interest is calculated on a daily basis.
However, it’s not really a question of interest, it’s just about squeezing more repayments into each year. And while it will save you money in the long term, in the short term it will only increase the size of your mortgage repayments.
When banks, and most mortgage calculators, work out the difference between monthly and weekly repayments, they take your total annual repayments and divide them by either 12, for monthly, or 52 for weekly.
Working with our example above – $500,000 principal and interest mortgage at 6.66% over 20 years:
- Weekly payments of $870 x 52 week = $45,240 p/a (Total interest over 20 years: $405,105)
- Monthly repayments of $3775 x 12 months = $45,300 p/a (Total interest over 20 years: $406,027)
In essence, you’re paying the same amount, just divided differently. You pay a fraction more, but not much, hence the paltry interest savings of $922 over two decades.
To reduce your interest charges, you’ve got to pay off more of your mortgage more frequently! And this is the crux of the weekly/monthly payment argument. To achieve the savings promised by those promoting weekly or fortnightly payments, you’ve got to use the monthly payment of $3775 above as your starting point, not the annual total:
- Monthly repayment ($3775) divided by 4 = $943.75 per week
- Annual total ($943.75 per week x 52) = $49,075
Using our example, by paying the extra $73.75 per week you end up making an extra month’s worth of repayments per year. Over the course of the mortgage, it shaves two years off the loan’s duration, and the total amount of interest paid shrinks to $336,627. That’s a saving of $69,400.
The bottom line is that there’s no magic formula to paying off your mortgage faster and paying less interest. As with all loans, the more you repay, the faster your debt will evaporate.
Claim your equity benefits
If you bought your house a few years ago with a deposit of less than 20%, you could still be paying more interest than you need to.
Because low-deposit borrowers are at a greater risk of defaulting on their loans, they are charged extra for their mortgages. The extra cost comes in the form of a low equity premium (LEP), either higher interest rates, or an additional one-off charge on top of a mortgage. Depending on the size of the deposit and lender, an LEP can range from an extra 0.25% to 1.5% p.a. in interest, or a 2% premium on the loan amount.
But banks don’t actively revise their customers’ LEPs. So if you’re paying an LEP in the form of extra interest, it’s worth contacting your bank and asking them for a re-evaluation of the price of your home and your equity in it.
If your level of equity has risen about the 20% threshold, you could receive a revised interest rate and enjoy substantially lower repayments.
If your home loan is up for refinance this year, take the time to shop around. While it’s easy just to stick with the same lender, you could miss out on a far lower rate. And don’t be scared to bargain. Your lender could well match a competitor’s rate if you threaten to jump ship.
Although all mortgage rates are now a lot higher than they were a couple of years ago, there remains a wide disparity between the lowest rate on our tables, 6.29% (1-year fixed), and the highest, 8.09% (1-year fixed rate). So for canny consumers who are prepared to do their homework and search out the lowest mortgage rates, there are still savings to be made.
For example, the table below displays some of the 2-year fixed-rate home loans on our database (some may have links to lenders’ websites) that are available for home owners looking to refinance. This table is sorted by Star Rating (highest to lowest), followed by company name (alphabetical). Products shown are principal and interest home loans available for a loan amount of $500K in Auckland. Before committing to a particular home loan product, check upfront with your lender and read the applicable loan documentation to confirm whether the terms of the loan meet your needs and repayment capacity. Use Canstar’s home loan selector to view a wider range of home loan products. Canstar may earn a fee for referrals.
An offset account is a transaction account that is linked to your home loan. The account’s balance (or a proportion of that balance) is offset daily against your home loan balance.
This means the more money you have sitting in your linked account, the less interest you pay. Some lenders will even allow you to link multiple accounts to your offset account, which can lead to even great savings.
However there are a couple of points to consider.
– The linked accounts will not earn interest. But given that mortgage rates are considerably higher than term deposit rates, you’ll still save money
– Offset accounts are commonly linked to home loans with variable rates, which tend to be higher than fixed-rate home loans. So it’s not wise to offset all of your mortgage, unless you’ve a huge amount of spare cash in the bank. Rather it’s a better idea to offset just a small part of your mortgage, to match any lump sum that you have regularly sitting in your bank account. For example, if you’re self-employed and set aside money for your taxes and ACC, you could consider offsetting the account against your mortgage.
Use spare cash to reduce your mortgage or extra repayments
As we mention above, the best way to reduce your mortgage costs is to reduce your mortgage. If you’ve money sitting in an account accruing less interest than you’re currently paying on your mortgage, using it to reduce your mortgage debt could be beneficial.
Some banks will allow you to make extra annual lump-sum repayments off your mortgage as long as they are no more than 5% of your current loan amount. Many will also allow you to increase your regular repayments towards your home loan by up to $250 a week.
While these are not short-term solutions to a budget squeeze, in the new environment of higher interest rates, they could save you thousands of dollars off the cost of your loan.
Check with your lender as to what extra home loan repayments they permit.
→ Related tool: Canstar’s Extra Home Loan Repayments Calculator
If you are facing severe financial stress, it could be appropriate to consider talking to your lender about taking a mortgage holiday – a break from making repayments on your mortgage for a few months.
Of course, halting your repayments means that you won’t be paying off your loan as quickly, and with compound interest, in the long run, you could end up paying much more for your mortgage. But a repayment holiday could give you the breathing space to get your finances under control.
While it might seem a drastic measure, if your mortgage has become unaffordable, it’s always worth looking past any emotional attachment you have with your home and considering selling up.
Financial stress can cause emotional and physical harm. And if you mortgage has become truly unaffordable, shifting to a new home with a smaller home loan, could be the best move you ever made.
First home buyers: compare home loans with Canstar
If you’re in the process of securing finance, you’ll need to shop around to get the best deal. Which is where Canstar can help.
The table below displays some of the 2-year fixed-rate home loans on our database (some may have links to lenders’ websites) that are available for first home buyers. This table is sorted by Star Rating (highest to lowest), followed by company name (alphabetical). Products shown are principal and interest home loans available for a loan amount of $500k in Auckland. Before committing to a particular home loan product, check upfront with your lender and read the applicable loan documentation to confirm whether the terms of the loan meet your needs and repayment capacity. Use Canstar’s home loan selector to view a wider range of home loan products. Canstar may earn a fee for referrals.
About the author of this page
This report was written by Canstar’s Editor, Bruce Pitchers. Bruce began his career writing about pop culture, and spent a decade in sports journalism. More recently, he’s applied his editing and writing skills to the world of finance and property. Prior to Canstar, he worked as a freelancer, including for The Australian Financial Review, the NZ Financial Markets Authority, and for real estate companies on both sides of the Tasman.