If you’re in a position to be able to make lump sum payments off your home loan balance, do you sometimes wonder whether it’s the best option even though you know reducing debt is generally a good thing?
There are a few things you should weigh up:
1. The benefit
2. The cost
3. The opportunity cost
4. Restructuring instead
The benefit: If you reduce your home loan balance from a lump sum payment, you pay less interest and you’re giving yourself the best opportunity to pay your loan off faster which is a great thing. Pretty simple really.
The cost: Otherwise known as “break cost”. Refer to THIS article for more on how break costs are calculated. In an increasing interest rate environment like we have been in (and possibly still in) your break cost is likely very little (please check with your bank though).
The opportunity cost: This is giving up the use of this cash for another purpose when you make a lump sum repayment. This could be buying a new car, going on holiday, investing in another asset class (shares etc), the list could go on forever.
But what about if I restructured my home loans instead? Banks have “Revolving Credit” facilities which you can repay and redraw as you please. If the balance is fully paid off, you pay not interest on that portion of the home loan. So by restructuring your fixed rate loans into a revolving credit facility, you can effectively make a lump sum repayment AND retain access to that cash should you need it for something else (cue opportunity costs) in the near future. There are a few other factors such as change in interest rates and max revolving credit limits which you should talk to me about if you’re interested. But it’s a great way to reduce debt without giving that cash up entirely. Give it some thought!