Lump Sum Payments: Are They a Good Idea?

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Key Takeaways

Key PointDescription
What are lump sum payments?Lump sum payments are large payments made in addition to regular monthly mortgage payments, allowing homeowners to pay off mortgages faster.
Benefits of lump sum paymentsMaking 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.
Things to consider before making a lump sum paymentBefore making a lump sum mortgage payment, ensure you can cover it without compromising other financial obligations and maintain an emergency fund.
How much is the ideal lump sum payment?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.
 

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.

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.

 

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