Key Takeaways
- Lump sum payments are large payments made in addition to regular monthly mortgage payments, allowing homeowners to pay off mortgages faster.
- Making lump sum payments towards your mortgage can significantly reduce the total interest paid over the life of the loan, shorten the loan term, and increase your home equity. It provides substantial financial benefits and helps you achieve mortgage freedom sooner.
- Homeowners, especially in regions with higher loan amounts, can save the most by making these extra payments early in their loan period.
- Before making a lump sum mortgage payment, ensure you can cover it without compromising other financial obligations and maintain an emergency fund.
- Your mortgage's ideal lump sum payment depends on your financial situation and terms. Consider factors such as loan amount, interest rate, and the timing of the payment, or use an online calculator to determine the best amount for your circumstances.
Are you a homeowner who’s still paying off your mortgage? One way to pay it off faster is through making lump sum payments, which are large payments made on top of your monthly mortgage repayments.
Simply put, they can help you pay off your mortgage sooner and reduce your total interest over time. However, this isn’t a one-size-fits-all solution. Whether this is right for you will depend on your circumstances and the terms of your mortgage.
Three Lump Sum Benefits You Should Know
Paying extra money towards your mortgage in one go, known as a lump sum payment, can massively change how much you pay overall and how long you’ll make payments. Here are some lump sum benefits homeowners should know:
It Reduces Overall Costs
According to the Australian Bureau of Statistics, as of December 2023, Australia’s average home loan size is $624,383, with an average interest rate of 6.28% per annum. Based on these figures, the estimated average monthly repayment over a 30-year term would be around $3,450.
This average can differ across different states and territories. For instance, in New South Wales, the average home loan size could be higher, reaching up to $785,000, while in the Northern Territory, it might be lower, at around $450,000.
Making a lump sum payment directly reduces the principal balance of your mortgage, reducing the total interest over the life of the loan. This gives homeowners substantial savings, especially if made early in the amortisation period.
Given the average home loan sizes and interest rates, homeowners in regions with higher loan amounts, such as New South Wales, could benefit the most.
It Shortens the Loan Term
Lump sum payments on your mortgage can shorten the loan term and help you become mortgage-free sooner.
Suppose you took out a $400,000 loan to buy a house with a 4% annual interest rate. If you agree to pay it back over 30 years, your monthly payment would be around $1,910.
After making these payments for five years, you still owe about $361,790.
Now, let’s say you are making a lump sum payment of $20,000 off your loan. Your remaining loan balance would be $341,790.
Even though your monthly payment remains the same at $1,910, the lump sum payment will shorten the overall loan term. In this example, this means you will be mortgage-free a few years earlier than planned, save over $30,000 in interest, and pay your home off more than two years ahead of time.
| Without a Lump Sum Payment | With a Lump Sum Payment | |
|---|---|---|
| Remaining balance after five years | $361,790 | $361,790 |
| Lump sum payment | $0 | $20,000 |
| New balance | $361,790 | $341,790 |
| Monthly repayment | $1,910 | $1,910 |
| Original term | 30 years | 30 years |
| New term | 30 years | 27 years 9 mos |
| Overall savings in interest | N/A | $31,942 |
It Increases Home Equity
Making lump sum payments on your mortgage increases your ownership of the property. Home equity represents the portion of your property that you truly own, calculated as the value of your home minus the remaining mortgage balance. Building more equity benefits your finances by providing a safety net during uncertain times.
For example, if home prices drop, having more equity means you’re less likely to owe more than your home is worth. More equity can also help you get better deals if you refinance your mortgage. With more equity, you qualify for lower interest rates or better loan terms, saving you money every month and over the life of your loan.
Some Lump Sum Payment Drawbacks to Know
There can be potential disadvantages to paying off your mortgage in Australia using lump sum payments. Here are some things to watch out for:
It Reduces Liquidity
Once funds are paid to your mortgage, they are no longer easily accessible. This can be a problem if you need cash for unexpected expenses or other opportunities. When you plan to make lump sum payments, make sure to factor in the payments into your budget and avoid dipping into your reserves or compromising your budget.
It Can Come With Possible Break Fees
Certain loan types, particularly fixed rate mortgages, may involve fees for making extra payments or paying the loan out early. Before you make lump sum payments, check your loan agreement or talk to your lender if it’s possible to do so without incurring break fees.
It May Not Bring The Most Returns
Directing funds to your mortgage may not always provide the best financial return. Depending on your risk tolerance, investing surplus funds elsewhere could potentially deliver higher growth than the savings achieved through reduced interest.
How Much is the Ideal Lump Sum Payment?
The right lump sum payment for a home loan depends on your finances, mortgage terms, and why you’re making the payment. There’s no simple answer, but here are some things to think about when deciding how much to pay:
The best lump sum payment for your mortgage depends on factors like your loan amount, interest rate, and how far into your loan term you are. For example:
- If you have a $500,000 mortgage with a 7% interest rate and a 25-year term, making a $10,000 lump sum payment after 5 years could shorten your mortgage by 11 months and save you $29,212.06 in interest.
- Similarly, for an $800,000 loan with a 4.5% interest rate over 30 years, adding $100 extra to your monthly payments and a one-time $10,000 lump sum in the sixth month could shorten your loan term by two years and two months, saving you $62,438 in interest.
Additionally, consult with a loan expert or use a lump sum calculator online to finalise your decision based on your capabilities and loan terms.
Things to Consider Before Making a Lump Sum Payment
Here are the final things to consider before reducing your mortgage balance and becoming debt-free sooner:
Personal Circumstances
The most important factor is to know how much you can pay without compromising other financial obligations and emergency funds. Secure an emergency fund before allocating some of your income to a lump sum mortgage payment. Finance experts recommend saving $2,000 to $15,000, depending on living expenses and mortgage size. This should be maintained to cover unforeseen circumstances without resorting to high-interest debt.
Pro tip: Having an offset account that you can make extra repayments into is a way of having an emergency fund that also reduces your interest.
What Happens When You Pay Off Your Mortgage with Lump Sum Payments?
Making lump sum payments can bring you closer to full ownership of your property far sooner than scheduled repayments alone. Since these additional payments reduce your principal, the interest charged over time also decreases, which can shorten the term of your loan considerably. In some cases, consistent use of lump sum payments can help you pay off your mortgage years ahead of schedule.
When the final repayment is made, your lender will arrange for the mortgage to be discharged and the title updated to show you as the sole owner. From that point, your regular mortgage repayments will stop, improving your household cash flow and giving you greater financial flexibility.
The Best Time to Make a Lump Sum Mortgage Payment
The timing of a lump sum payment can have a big effect on how much interest you save over the life of your loan. Generally, the earlier in your mortgage term you make the payment, the greater the benefit. This is because more of your scheduled repayments will go towards reducing the principal rather than servicing interest.
It may also make sense to consider a lump sum payment when you have received additional income, like a tax refund, bonus, or inheritance, as long as doing so doesn’t compromise your cash reserves. For borrowers on fixed rate loans, it is important to check with your lender first, as some products impose break fees.
In short, a lump sum payment is most effective when it is made early, does not put pressure on your household cash flow, and is aligned with your loan’s conditions.
Is It Better to Make a Lump Sum Payment or Extra Monthly Payments?
Both lump sum and additional monthly payments can reduce the total interest payable and shorten the life of your mortgage. The best approach often depends on your financial situation.
- Lump sum payments immediately reduce the loan balance and can be very effective if made early in the loan term. They are great for situations where you receive irregular income, such as a bonus or inheritance.
- Extra monthly payments allow you to regularly and steadily decrease the loan balance. This method can be easier to incorporate into a household budget and provides interest savings over time.
Many borrowers find that a combination of both strategies is most effective. Regular smaller contributions, supported by occasional larger payments when funds allow, can definitely speed up paying off your loan.
If you’re planning to make extra repayments, you can use our home loan calculator and our extra repayments calculator to see how much you’ll potentially save in interest and how much time you’ll shave off the life of your loan.
Disclaimer: Loans and their accompanying benefits are available only to those who qualify for them and have been approved. Though we put a lot of care into writing this article, the information presented within is general and doesn’t consider your unique situation. It is not meant to serve as a substitute for professional advice, and you should not rely on it solely for any major financial decisions. You should always consult with a professional when you’re dealing with finance, tax, and accounting matters.
Take Control of Your Loan with Expert Lending Solutions
Making lump sum payments is a smart move that can save you money in interest and help you pay off your loan faster. However, before you do, consider the penalties and your finances. Not sure if allocating that money elsewhere might yield better returns?
We can help you evaluate your options and determine if making lump sum payments is right for you.
