Can you repay your home loan at the “buffer” rate and save

In Australia, households often choose to pay down their mortgage more quickly than required. Various data sources suggest that around half of borrowers are ahead of schedule on their mortgage. In this way, many households have a buffer that they could temporarily draw on to stay current on their loan repayments if their incomes were to fall. Mortgage holders could save hundreds of thousands of dollars in home loan interest if they made repayments at their bank’s “buffer” rate, according to Mortgage Advisers.

When a lender determines whether a borrower can afford a loan, they do so by adding an interest rate buffer of around 2% p.a. to the current home loan rate. In other words, if the current interest rate is 5.25% p.a. they will assess the ability to repay the loan at 7.25% p.a.

Households have now built up a significant buffer against future interest rate rises, figures from the Bureau of Statistics and Reserve Bank show. A debt reduction strategy simply requires you to make monthly loan repayments based on an interest rate that is always 2% higher than your current rate.

“This is one of the most simple and effective debt reduction strategies that home-owners can use,” said Smartline’s Executive Director, Joe Sirianni.

“While making higher home loan repayments might ordinarily be a stretch for some people, the historic low interest rates we are currently enjoying make this a strategy that pretty well everyone should be able to adopt.

Take the example of a $350,000 mortgage. At 5.25% the monthly repayment is $1932.71. At 7.25% p.a., the monthly repayment is $2387.62 – an additional cost of $454.91 monthly.If you were to add this $454.91 to your monthly repayments, the result would be impressive.
The loan would be paid off in just 19 years and seven months, rather than 30 years. And by paying your loan off so quickly, you would save $134,993 worth of interest.

“While this calculation is made on the assumption that the variable rate will stay at 5.25% p.a., which almost certainly it will not, it does highlight the considerable impact that making additional repayments has on your home loan,” Mr Sirianni said.
“An experienced mortgage adviser should be happy to work with you to work out how this strategy would benefit your own personal situation.”