The cash rate has climbed to 4.60% after four rises this year, and many borrowers are asking the same thing. Is it smarter to throw extra money at the loan, or keep cash on hand? Here is how extra repayments work, what they can save you, and when they make sense.
Should you make extra repayments while rates are rising?
For most borrowers with a stable budget, the answer is yes, but only after a few other boxes are ticked. Extra repayments cut your balance faster, which cuts the interest charged every month. When rates rise, each dollar of balance costs you more, so paying it down earns a guaranteed return equal to your loan rate.
How extra repayments actually work
Interest on a home loan is calculated on your balance, usually daily, and charged monthly. Any extra money you put in lowers the balance straight away. Next month's interest is then calculated on a smaller number.
Your required repayment stays the same unless you ask the lender to recalculate it.
The extra goes mostly to principal, so the loan ends sooner.
The earlier in the loan you pay extra, the bigger the saving.
What a small top-up can save you
Here is an example. Say you have a $600,000 loan over 30 years at 6.50% p.a. The minimum repayment is about $3,792 a month. This is an illustration only, not a quote.
Add $300 a month and the loan is cleared about five and a half years sooner.
Total interest drops by roughly $168,000 over the life of the loan.
If the rate rises another 0.25% on that same loan, the minimum repayment goes up by about $99 a month.
Rates change and your numbers will differ. The pattern holds though. Small, regular extras add up because they work against compounding interest.
Build a buffer before you pay extra
Paying down the loan feels good, but it can lock your cash away. Before you send extra to the lender, check you have a safety net.
Aim for at least three months of repayments and living costs in an accessible account.
Keep any high-interest debt, like credit cards, ahead of the mortgage. Clear those first.
Check your loan has no cap on extra repayments. Most variable loans allow unlimited extras. Fixed loans often cap them, commonly around $10,000 to $30,000 a year.
If your budget is already tight, our guide on mortgage stress in Australia covers what to do before it becomes a bigger problem.
Offset account or extra repayments?
An offset account gives you most of the interest saving of an extra repayment, but your money stays reachable. Interest is calculated on your loan balance minus the offset balance. You can pull the cash out whenever you need it.
Extra repayments to the loan itself may be available to redraw, but that depends on your lender and loan.
An offset account is usually the more flexible option for your buffer.
Some loans with offset accounts carry a higher rate or annual fee, so check the full cost.
We break down the difference in Offset Account vs Redraw: What's the Difference? if you want the detail.
Set it up so it happens automatically
The easiest way to stay consistent is to automate it. Willpower fades. A scheduled transfer does not.
Switch to fortnightly or weekly repayments. Because there are 26 fortnights in a year, you make the equivalent of one extra monthly repayment without really noticing it. Check how your lender calculates this, as it varies.
Keep your repayment at the old, higher level after a rate cut. You will not feel a change, and the extra goes straight to principal.
Send windfalls, like tax refunds and bonuses, to the loan or offset account.
When extra repayments may not be the best move
Extra repayments are not right for everyone. Think twice in these cases.
You are on a fixed rate with a low cap on extras and break costs if you go over.
You have little or no emergency cash.
You could get a better return from other priorities, like paying down non-deductible debt before investment debt, or topping up super. Check with an accountant on your own situation.
Your rate is well above what the market offers. In that case, refinancing or asking for a better rate may save more than extra repayments.
Check your rate at the same time
Paying extra on a loan with an uncompetitive rate is like filling a bucket with a hole in it. Before you commit to extra repayments, have your rate reviewed. If it is higher than what new customers are getting, a rate review could save you more each month than a $300 top-up.
Compare your current rate to what lenders are offering now.
Ask your lender for a rate review, or ask us to compare options.
Look at fees, features and offset options, not just the headline rate.
Ready to Pay Your Home Loan Off Faster?
Every loan is different. We can look at your rate, your features and your budget, and show you what extra repayments could save you. This is general information only and not financial advice.