Should You Pay Down Debt When Interest Rates Drop?
So, your bank has reduced your home loan interest rate…happy days, less debt!
Though some banks are not always in a hurry to drop their own rates, however, most banks get on board pretty quickly and reduce their interest rates.
The official cash rate (OCR) is the term used in Australia and New Zealand for the bank rate and is the rate of interest which the homogeneous central bank charges on overnight loans to commercial banks. This allows the Reserve Bank of Australia and the Reserve Bank of New Zealand to adjust the interest rates that apply in each country’s economy.
The OCR cannot be changed by transactions between financial institutions as this does not change the supply of money, only its location. Only transfers between the central bank and an institution can affect the OCR.
Currently, the Australia OCR is 1.00%
Currently, the New Zealand OCR is 1.00%
The Reserve Bank of both Australia and New Zealand are expected to cut the OCR again in the near future.
You have debt – a mortgage, what should you do?
But what now, should you still continue to pay down your debt at the same rate or enjoy the extra cash flow?
You could just leave it in your “spending account” and splurge on some take-out and a couple of movie tickets.
Or, do what the wealthy wise do, and make that money work for you.
On an average home loan of $400,000 with an interest rate of 4.28%, your monthly repayments would be around $1,975.
With that rate reduction, your interest rate is now sitting at 3.78%, and your monthly repayments have dropped to $1,860.
That’s $115 per month that can drive down your credit card debt, or your personal loan, or your mortgage!
Good debt versus Bad debt
We have discussed Good debt versus Bad debt before.
Good debt being debt that creates a passive income, sees you enjoying the tax benefits, sees you owning your own home sooner, sees you retiring sooner, and sees you not playing the banks game.
Bad debt sees you paying compounding interest, sees you with a 30-year home loan, personal loans, savings accounts and credit card debt, sees the equity in your own home not being utilised and sees you playing the banks game.
Not in your best interests at all, do you need help in debt consolidation contact us, it’s a free chat.
How the wealthy use interest rate cuts
The wealthy wise see it all very differently and the following example of just how the wealthy view even a $115 a month “windfall” by way of that interest rate drop is quite interesting, and something to consider.
It doesn’t sound like much really, but $115 per month adds up, and creating a financially healthy mindset begins with seeing that windfall’s potential (and it’s not in pizza and the movies!).
One way is to keep paying the same repayments you did before this “windfall”, after all, you were managing it, so why change it?
That’s financial maturity right there!
Another is to pay that extra $115 you now have into your other personal debts, your credit cards, for example, to help start a debt recovery.
Although, if you’re truly switched on, your home loan has the correct facilities, and you don’t have additional personal loans and credit cards.
But if you’re still playing the banks game, and you have a credit card, then realise that the interest rate on that is probably 4 or 5 times higher than what your home loan interest rate is and paying an extra $115 per month off that is certainly a very responsible thing to do.
Why a credit card at 19.99% is not reasonable
Financial maturity starts with recognising the true potential of your money!
For example, say you have a credit card with a $10,000 limit – fairly standard these days. Also, fairly standard is the interest rate of 19.99% (how anyone can think that’s standard, reasonable or acceptable is beyond our comprehension!)
Let’s say your current balance sits around $7,500.
Your bank will ask you to pay the minimum payment of $155.26 for that month.
It will take you 50+ years to pay off that $7,500 if you do what the bank has asked you to do!
Let that sink in for a minute … FIFTY PLUS YEARS!
Use this free credit card calculator to calculate how long the amount of interest you pay.
Let this sink in too – you have then paid in excess of $30,000 in interest – on the initial amount of $7,500.
Pay that $115 into the same credit card, each month as an additional payment, and you can potentially pay off that credit card – in full – in about 3 years.
You end up only paying about $2,500 in interest – instead of $30,000.
That’s valuing your money, and making it work for you!
How to save $60,000 in interest and be debt free
Let’s use the same math in figuring out what that $115 extra per month can do for your home loan.
Using our initial example of a $400,000 home loan, if you did just keep paying the same repayment of $1,975 per month, you would reduce your home loan from 30 years to 27 years.
That’s 3 years and over $35,000 saved in interest!
And all you’ve done is what you’re doing right now, paying the same repayment. Now here’s something your bank probably didn’t mention.
Still using the same example as above, but pay your mortgage fortnightly, instead of monthly.
Keep paying the same amount of $1,975 and … You have just reduced a 30-year home loan to 24 years!
And saved in excess of $60,000 in interest. Better than pizza and movies!
This is a very basic example, and your Mortgage Broker can certainly show you even smarter ways of not playing the banks game any longer.
It doesn’t matter which bank you’re with, they all have facilities in place and strategies that allow you to own your home sooner, to build equity for your future wealth creation.
They all have these, yet few will help you in the way a Broker will and fewer still will set your accounts up in a way that serves your best interests.
Banks are in the business of making money, not saving you money
Banks will happily sell you a personal loan, a credit card or two and make it really easy for you to just pay the minimum amounts due.
They even put that on their credit card statements – “Minimum payment due”.
Sadly, for a lot of people, they unwittingly play the banks game.
“Well, if that’s all the bank wants this month, then that’s what I’ll pay”. (and keep paying, for years on end!).
The banks make money by selling you money at high-interest rates on home loans, or even astronomical rates on credit cards and personal loans.
Yet when it comes to paying you for your savings money, the rates are somewhat less, by a lot!
Own your home sooner
Play the long game that sees you owning your home sooner, creating equity in your home and using that equity to start your investment strategies, your portfolio of properties earning you an income.
Convert your Bad debt (home loan) into Good debt (investment properties) and it all starts by not buying pizza and movies on the $115 you gained when the Reserve Bank of Australia or New Zealand dropped the cash rate to an all-time low.
Use the bank’s money wisely to create wealth not bad debt
It starts by seeing a Mortgage Professional and becoming part of the wealthy wise, who see the potential in that $115 working for them.
Remember the saying a dollar saved is better than $2 earned!
Still the same mindset today, for every dollar you don’t have to work for, but you can benefit from, is worth double that to you in creating a financial future that benefits you, and not the banks.
Use their money to create your own wealth.
Pay that money back quicker, smarter and with the least amount of compounding interest, and you are becoming part of the wealthy wise!
Talk to us today for debt help, and start this journey for yourself, for your family and leave a legacy to be proud of to be debt free.
Or pizza and movies and keep the banks happy.