How to make the most of low interest rates

With Australia's official cash rate at a 53-year historical low of 2.5 percent, Australian home owners are enjoying lower mortgage repayments than ever.

When the Reserve Bank of Australia passed the most recent rate cut in August, the move shaved $45 a month on the average mortgage of $300,000 – a saving of $540 a year. Coming on the back of five previous cuts since January 2012, most Australians are saving thousands of dollars on their mortgage.

So, what’s the best way to spend the extra cash? “It might be boring, but putting the extra money back on your mortgage is the best ting you can do,” says Greg Pride, financial adviser with Centric Wealth.

“If you are paying a 6 percent interest rate on your mortgage and you’re an average tax payer, you would have to get a financial investment with a 10 percent rate elsewhere to be comparable to paying off your mortgage – that’s a tough gig.”

Marc Bineham, MD of Noall & Co and national vice president of the Association of Financial Advisers, agrees. “If you leave the extra money on the mortgage, it comes straight off the principal [the original amount you borrowed], and it pays off your mortgage quicker,” he says.

Mortgage sense

Paying more than the minimum repayments on your mortgage will cut the amount you owe shorten the life of your loan – saving you tens of thousands of dollars in the process.

For example, a $500,000 loan amount on a 25-year loan term and 5.2 percent interest rate, with repayments made monthly, could end up costing you $894,452 in principal and interest (assuming rates remain steady). Paying an extra $373 a month will shave almost five years off the life of your mortgage, and save you $89,048.

Alternatively, refinancing the same loan into a low rate variable home loan such as 4.49 percent (the lowest variable option at the time of writing), would free up $206 per month or $2472 in the first 12 months. If reinvested into the loan, it could mean interest savings of over $44,000 over 25 years – without having to impact your lifestyle!

Savings benefits

While Bineham and Pride agree that putting any money you save from lower interest rates back into your mortgage is the best-case scenario, they also approve of directing the spare money into savings – giving high-interest savings accounts the thumbs up.

Pay off other debts

If you have credit card debt or other debts accruing a higher interest than your home loan, use the money you are saving on your mortgage to pay off that debt. With interest rates on some credit cards as high as 20 percent, credit card debt is one of the most expensive debts to carry.

For example, if you owe $1000 on your credit card and pay it off at the minimum repayments of 2 percent, it will take you more than eight years to repay the full amount and you will fork out $924 in interest – almost twice the original amount.

Hedge your bets

If you’d like to enjoy the benefit of an increased disposable income thanks to your mortgage savings, Bineham suggests splitting the extra cash into three. “You can put one third into your mortgage, one third into savings and the remaining third into spending,” he says.

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