There is a serious problem regarding home loans, which is affecting tens of thousands of Australians according to Doug Mathlin, founder of Smart Borrower.
He believes too many Australians are paying too much interest over the life of their home loan.
So he wrote a letter to Federal Treasurer Josh Frydenberg proposing what he said was a simple solution.
As the letter to the Treasurer explains, the main reason people pay too much interest is not always because their interest rate is too high, but because they don't have a plan to pay off their loan.
Mathlin says it's not the lender's responsibility to be concerned with borrowers who "set and forget" their mortgage, so he proposes that borrowers have a repayment plan with strategies to significantly reduce the loan term and the interest payable.
Now in isolation, this makes sense, however in my mind, for many Aussies, it would make more sense to put the money for extra repayments as well as any spare cash into an offset account until you have sufficient funds for a deposit to buy an investment property and then not only will your home increase in value, but so will your investment
Anyhow...here is the letter Mathlyn sent the Treasurer...
Dear Treasurer Frydenberg,
I'd like to alert you to what I believe is a serious problem regarding home loan borrowers – and then to propose a simple solution.
The problem I see is that too many Australians are paying too much interest over the life of their home loan.
There have been many recent reports highlighting concerns about Australia’s high household debt and that a crisis that will emerge when interest rates rise.
One reason, of course, is that “the significant majority of interest rates paid on older home loans are higher and in many cases materially higher, than the average interest rate paid on new loans,” as the ACCC’s Home Loan Price Enquiry reported in 2020.
The bigger reason, though, is that many Australians take too long to pay off their home loans.
As a result, they end up paying way too much interest and taking years longer to repay their loan.
Many Australians don’t realise they could save tens of thousands of dollars by paying off their home loan ahead of schedule.
The 2 questions that every borrower should be able to answer about their home loan are:
- What day will this loan be repaid?
- How much have l got left to repay (this is not the loan balance, but rather, how much do l have left in repayments including future interest)?
To reduce the amount of interest paid, borrowers should have a repayment plan with strategies to significantly reduce the loan term and the interest payable.
They should also be able to track their progress as they pay down their loan, as external factors affecting their loan continually change i.e., new lender offers, interest rate changes, etc.
TAKE OUR 3-MINUTE SURVEY: How do you compare to other property investors?
Why does the problem exist
Happily, the Reserve Bank of Australia’s most recent Financial Stability Review showed that most borrowers are ahead on their mortgage.
Tens of thousands, though, are not.
Of course, some borrowers don’t have the immediate capacity to get ahead on their mortgage, although the situation may differ if they were aware of the opportunity to be debt-free.
Borrowers need to learn that every financial choice made during the life of their loan has a positive or negative consequence.
Choosing to spend more money on consumables i.e., updating the car, holidays, new TV’s, means less money available to repay the loan.
Understanding the consequences of the choices they make with their money, and the resulting impact of that decision on their loan is key to paying down non-deductible debt”.
Many Australians struggle with financial literacy.
In the 2018 Household, Income and Labour Dynamics in Australia Survey, only 42.5% of respondents were able to give correct answers to all five financial literacy questions.
Consequently, borrowers don’t realise how much money they could save by planning and regularly reviewing their loan progress.
How to solve the problem
There’s a logical solution to this problem.
Under the National Consumer Credit Protection Act 2009, lenders are required to provide borrowers with a personalised key facts sheet when they plan to take out a mortgage.
My suggestion is to go much further; borrowers should have a repayment plan that outlines how to reduce the loan term and save thousands in interest at the same time.
Responsible lending shouldn’t just be about the borrower’s ability to repay their loan when they apply for one ‒ it should also include education about ‘loan literacy’ and access to assistance during the repayment term.
If we take the hypothetical $400,000 home loan with an interest rate of 2.50%, the borrower should be aware of the following:
- If you pay off your loan over 30 years, your monthly repayment will be $1,580 and your total interest bill over the life of your loan will be $168,974
- If you pay off your loan over 25 years, your monthly repayment will be $1,794 and your total interest bill over the life of your loan will be $138,340
- If you pay off your loan over 20 years, your monthly repayment will be $2,120 and your total interest bill over the life of your loan will be $108,707
Many borrowers would be shocked to discover how much money they could save by paying off their mortgage early.
By presenting borrowers with the different repayment scenarios and with information about the strategies available to repay debt, they could then formulate a plan that helps them pay off their loan sooner.
Another alarming element to this issue is that many Australians are carrying debt into their retirement, meaning they often use part of their superannuation to pay off their loan.
This is not what retirement funds are for - every borrower should have a plan to be debt-free before retirement.
Using superannuation funds to clear personal debt reduces their ability to self-fund their retirement which, in turn, means they’re more likely to have to rely on a government pension.
So, this is as much of a social problem as it is a financial problem.
It’s time we solved it.
TAKE OUR 3-MINUTE SURVEY: How do you compare to other property investors?
