The 'set and forget' strategy that saves a typical homeowner $104,569

The changes to tax rates that came into effect July 1 are expected to increase homebuyers borrowing capacities by tens of thousands of dollars, potentially providing a tailwind to the affordable end of the property market given first-home buyers are set to benefit most.

But for people who already own a home, and are paying off a home loan, the income boost can have a much larger effect.

Analysis of the effect of tax cuts by realestate.com.au shows that borrowers who don’t spend their tax cut and instead put the money towards their mortgage or into their offset account will stand to save almost five times that amount over the life of their loan.

A borrower on a typical income with an average sized mortgage would save almost $11,000 over the life of their loan if they put just this year’s tax cut towards their home loan as a lump sum. They’ll also pay off their home loan about three months earlier.

How much you would save if you put this year's tax cut towards your mortgage - individual

But if that same borrower kept up the habit and put the equivalent of this year’s tax cut towards their mortgage every year for the life of their loan, they would save more than $100,000 in interest and shave three and half years off their loan.

The effect would be even greater for those on higher incomes or dual income households because the larger boost to their incomes from tax cuts means they could put more in extra repayments towards their mortgage.

How much you would save if you put this year's tax cut towards your mortgage - dual-income households

The analysis uses the Mortgage Choice lump sum calculator and repayment calculator and assumes a borrower has the Australian average loan size of about $625,000, is paying an interest rate of 6.19%, has a loan to value ratio of 80% or less and a loan term of 30 years.

Using this scenario, an individual borrower earning $60,000 would save about $5871 over the life of their loan if they put just this year’s $1179 tax cut towards their mortgage. But they would save $60,767 if they kept up the habit, and pay their loan off two years earlier.

A borrower earning $100,000 — a touch higher than Australia’s average income of $98,098 — would save $10,798 from just this year’s tax cut, or $104,569 in total if they kept up the extra repayments. They would end up debt-free three and a half years earlier.

Homeowners could more than quadruple their tax cut by putting it towards their home loan to reduce their interest payments. Picture: Getty

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Meanwhile, a dual-income household with a combined income of $200,000 would save $21,373 over the life of the loan if both borrowers contributed just this year’s tax cut, which would also pay their loan off six months faster.

But that same household would save $180,572 and slash six years and two months off their loan if they continued making the equivalent to this year’s tax cuts in extra repayments every year.

'Take it out of play': Automated payments simplify saving

Mortgage broker James Algar of Mortgage Choice Dee Why said the figures showed how much of an effect extra repayments could have on reducing the total amount of interest paid on a mortgage.

“People tend to look at their giant home loan and feel like they aren’t getting anywhere,” he said. “But a small contribution is very effective in the long haul.”

Automating extra repayments puts the money out of reach and removes the temptation to spend. Picture: Getty

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He said making extra repayments was easier for borrowers if they set up automated payments to keep the extra funds out of reach, and continued living as if their incomes had remained the same.

“There’s a lot of value in what I call a ‘set and forget’ approach,” he said. “If you know next month you're going to get an extra $100 in your pay packet, contact your lender or jump online and set up a regular repayment to send that money to your home loan and effectively take it out of play.”

“The people who have it automated tend to stick with it.”

How much you would save if you put your tax cut towards your mortgage every year - individuals

Mr Algar said putting aside extra payments into an offset account had the same effect as making additional repayments because the balance of an offset account is deducted from the home loan principal when calculating interest repayments, thereby reducing the interest borrowers have to pay.

“Overall, so long as you leave that money in your offset account or leave it in your home loan it will have a near identical impact,” he said.

“The offset account achieves the same outcome as paying off the home loan, but gives you great flexibility in the future.”

How much you would save if you put your tax cut towards your mortgage every year - dual-income households

There may be tax advantages for investors who use an offset account rather than making additional repayments, Mr Algar said. But he urged borrowers to seek tailored advice from a broker or accountant.

“In most cases it makes better financial sense to put money into an offset account if it is an investment property, or may become an investment property in the future,” he said.

“If you make extra repayments and then redraw, it’s a new borrowing event, and you can only claim a tax deduction on money you borrowed to buy that property.”

Mr Algar said the principle of setting aside any extra income could also work in the future if and when interest rates are reduced.

The big banks think the next move for interest rates will be down, but the risk of another rise has increased recently. Picture: Getty

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“Leaving your payments high will do wonders,” he said. “If you’ve been coping with higher payments and higher interest rates and you’re able to get by and make ends meet, then when rates do fall and the bank writes to you to let you know your rate is coming down, tick the box that says you want to leave your payments the same.”

The big banks remain split on whether the first interest rate cuts will come later this year or whether borrowers will have to wait until next before rates are reduced.

But higher than expected inflation figures released last month have increased the likelihood of another rate hike to bring inflation down quicker.

Give your home loan a health check

Apart from making additional repayments, the simplest way borrowers could reduce their mortgage expenses was to regularly review their home loan, Mr Algar said.

“I am still getting people walking in paying up to one percentage point more than what their current bank would offer them if they just ask,” he said.

“I sat down with someone the other day who had 27 years left on his mortgage, with more than $2 million owing. His interest rate with a large bank was 7.14%.”

“What we did was reach out to his current lender and renegotiate the rate. They dropped it overnight to 6.14%.”

“I didn’t write a new loan for him, I didn’t refinance, and it didn't cost him anything.”

“His annual interest bill was down by about $20,000, and the total interest over the life of his loan was reduced by about $440,000.”

“It took half an hour.”