Get Sorted: How to pay less interest on your mortgage

Many people retire with too much house, not enough saved. The choices we make with our mortgages can tip the balance more in our favour. Picture / 123RF

You may have heard the mortgage rule of thumb a friend mentioned the other day: "With a mortgage, you're going to pay twice the cost of the house."

It's a bit more complicated than that. There's some "psychic maths" going on here: it is definitely possible to pay that much, but "it ain't necessarily so", as they say.

That said, it's a rule of thumb that may be generally helpful, as it draws attention to the end result of paying years of interest on a mortgage.

When you're borrowing, it can't be just about the property price; it's about the total cost of the loan – principal and interest. Heaps of interest, actually.

But whether you pay twice what you borrow depends on the interest rate and how long you take to repay. At today's mortgage rates – say $500,000 at 5.8 per cent – you could very well end up paying twice that by the time you're done… but only if you take 28 years.

It helps to run some numbers at higher interest rates to see the effect. With $500,000 at 1 per cent higher (6.8 per cent), you'd end up handing over $1 million after 24 years. At 2 per cent higher (7.8 per cent), you'd part with that cool million even sooner: 21 years.

You can easily see your own numbers on Sorted's mortgage calculator.

How to pay less interest on your mortgage

Interest on a mortgage is typically calculated daily – a non-stop ticker in the background that goes on for as long as we take to repay. When we make a scheduled payment, we're charged however much has built up to that point.

Back in a previous life when I was selling mortgages, I was continually struck at how much they were structured in the lender's favour when the borrower makes just the minimum payment.

Nowadays I'm here to tell you that there is something you can do about that. Here are the top strategies for paying off a mortgage quicker.

1. Limit the interest-bearing part of the loan as much as possible.
One thing we can do is limit our loan amounts, either by saving more of a deposit or finding a cheaper house. If not the entire loan, at least the part attracting interest.

Assuming you're borrowing only what is absolutely necessary to start, you can then further reduce the part of the loan that will accrue interest.

Do this by:

• Using an offset mortgage, where you link a savings account to your loan. The savings account reduces the part of your loan being charged interest. Although your savings don't earn any interest, they reduce the amount you'd pay on the loan.

• Or a revolving mortgage, where your pay goes into your mortgage account and you spend from there. This also reduces the amount of your loan accruing interest.

2. Dial up the amount you repay.
Beyond limiting the loan amount, the only way to pay less interest is to repay more or repay sooner. Or both!

You can structure your mortgage more in your favour by making higher repayments than required.

Here's how:
• Top up your repayment each time. Even most fixed rate mortgages allow you to increase your repayments by up to 20 per cent without any penalty.

• Add extra lump sums as you go. For fixed-rate loans this can incur penalties, so check first.

• Shorten the term of your loan, which will increase your repayments.

• Pay half your monthly amount each fortnight. Because there are 26 fortnights a year, this gives two more payments than you would have had.

• If interest rates drop, keep your repayment at the same level it was.

• Each time you receive a pay rise or a career break, keep your lifestyle the same and funnel the difference into your mortgage.

Though each additional amount may seem a small increase, it can shave off tens of thousands in total interest. Run your numbers!

Many people retire with too much house, not enough saved. The choices we make with our mortgages can tip the balance more in our favour.

Get Sorted is written by Sorted's resident blogger, Tom Hartmann (@TomHartmannNZ). Check out the guides and tools from Sorted – brought to you by the Commission for Financial Capability – at sorted.org.nz.