If your boss offered you a $4,224 pay rise today would you refuse it?
If you retain a home loan with an noncompetitive interest rate then you are actually knocking back an easy pay rise. A simple refinance may help you free up some cash flow and live life. Let me show you how.
Refinancing your mortgage is simply moving it from your current lender to another lender. By reviewing your home loan you may find a more suitable product that is better suited in helping you achieve your financial goals – whatever they may be.
Our ‘REFINANCING’ page gives an outline of the main reasons to refinance. It includes the ‘reasons to’ and ‘reasons NOT to’ refinance. In a nutshell, most people tend to refinance for the following reasons:
Improve your cash flow: lowering the interest rate reduces your loan repayments. This allows you to redirect your money to paying your expenses or for extra spending.
Shorten the loan term: Even though refinancing results in lower loan repayments, you can continue making the higher repayments. This will shorten the term of your home loan and the total payments you make over time – saving a lot of money.
Debt consolidation: you may have several high interest loans. Refinancing may allow you to consolidate all these loans into your home loan. Since the home loan will have the lowest interest rate you will save a LOT of money in interest.
Create long-term wealth: refinancing may allow you to access equity in your home to use for investment purposes (or even renovations as well). Lower interest rates will also free up cash flow and also allow you to regularly contribute to the investment.
I have touched on “DEBT CONSOLIDATION” in a previous article. This post and the next two will focus on the other three reasons you would choose to refinance your mortgage.
Refinancing to improve cash flow
Arguably the most popular reason to refinance is to have extra money each month. That is, to improve household cash flow. This is a very common reason because the extra money you save can be used to fund the lifestyle choices that matter the most to you. These could include:
- eating out with the family,
- going to the movies regularly,
- annual overseas holiday,
- and so on.
Basically refinancing to free up cash flow can allow you to do things that matter to you in life NOW – rather than waiting until later in life.
Refinancing to a lower rate is like a payrise
By reducing the interest rate that is paid on your mortgage you are able to free up spare cash. For example, if you owe me $100 and I charge you 5% interest per day you have to pay me $5 per day in interest. My wife may offer you $100 loan but only charge you 4% or $4 interest per day. You take the $100 loan from her, pay me out and are then saving $1 in interest per day. That might get you a couple of Chupa Chups each day that you couldn’t afford to buy when you owed me. That is refinancing to improve cash flow.
The best part is that you can get this lifestyle improvement without compromising your lifestyle by even $1. The loan will still take the same time to pay out but you will have the cash to do what matters to you sooner rather than later. Let’s look at a more realistic example using a $400,000 loan over 30 years.
In the chart above you will note that a 1% drop on a $400,000 loan will reduce the annual payments by $2,852. The total interest saved over the 30 year term is over $86,000. That is a lot of Chupa Chups.
In fact, the savings you make can be likened to receiving a pay rise.
For example, say you refinance and are now saving $2,852 per year. That is actually money you receive AFTER tax is deducted. You actually need to make a lot more than $2,852 before tax is deducted. The amount of money you would need to earn before tax is outlined in the table below for various tax brackets.
|Income||Income Tax Rate||Multiplier||Equivalent Payrise|
|$18,201 – $37,000||19%||1.23||$3,520|
|$37,001 – $90,000||32.5%||1.48||$4,224|
|$90,001 – $180,000||37.0%||1.59||$4,526|
The average Australian is in the 32.5% tax bracket. That means you would need to earn 1.48 x $2,852 = $4,224 before tax. So if you save $2,852 pa in mortgage repayments, it is the same as receiving a $4,224 pay rise.
This is a quick and dirty way to work out your pay rise. So for example, someone in the 32.5% tax bracket receives a pay rise of $148 for every $100 saved in loan repayments.
So by refinancing your home loan to a cheaper rate you are effectively giving yourself a pay rise. You can use that to buy more Chupa Chups. Or if that doesn’t really float your boat then put it towards any item or activity that gives you enjoyment.
If you are interested in a pay rise then you have a few options: