While certain debt can be used as a tool to leverage and build wealth, at some point, all debt must go. This is particularly true for debts incurred for consumption, as they have no place in a constructive financial plan.
By eliminating debt, you not only save on interest costs but also free up future cash flow. The regular repayments that were previously allocated towards debt can now be redirected towards other wealth-building strategies, such as investments or savings.
Accelerating debts with additional repayments
One effective strategy to pay off debt faster is making additional regular repayments above the minimum required amount. These extra payments go directly towards reducing the principal balance, allowing you to minimise the overall interest paid over the life of the loan.
Additional regular debt repayments can be made on various types of loans, such as mortgages, personal loans, credit cards, or student loans. The extra payments can be scheduled on regular intervals or applied ad-hoc whenever you have extra funds available. Where possible, we try to encourage automatic, regular repayments as this builds good financial habits.
Example
To give you an example of how powerful additional regular debt repayments can be, let’s consider the following example.
Tim and Nicole, have an outstanding home loan balance of $500,000 with an interest rate of 6.0%. Their minimum monthly repayment is $3,000. Recently, both Tim and Nicole received a well-deserved promotion at work, resulting in a boost in their income. Excited about their improved financial situation, they have decided to ramp up their home loan repayments to $4,000 per month.
| Liability | Balance Outstanding | Interest Rate | Minimum Repayment | Proposed Repayment |
| Home Loan | $216,831 | 6.0% | $3,000 per month | $4,000 per month |
| Months to Payoff | 360 months | 197 months |
By increasing their level of repayments by $1,000 per month, Tim and Nicole are on track to pay off their home loan in approximately 16 years and 5 months. This marks a significant improvement compared to their existing repayment structure, which would have taken approximately 30 years to pay off the loan. Not only that, but their diligent efforts will also save them a substantial $291,118 in interest along the way. Please note, these calculations assume that the interest rate remains at 6% throughout the life of the loan.
If you would like to calculate the benefit additional debt repayments can have for you, check out our Loan Repayment Calculator.
Benefits of additional regular debt repayments
Making additional regular debt repayments can have a number of benefits including the following:
- Quicker Loan Payoff: Regular additional repayments go directly into the principal balance outstanding and therefore help pay off your loan sooner. Even a small additional repayment may provide you with significant savings over the life of your loan.
- Interest Cost Savings: Additional repayments reduce the size of your loan and save on interest costs. Interest is typically calculated daily so the sooner you reduce your principal balance, the less interest you’ll pay over the remaining life of the loan.
- Tax-free return: Any funds you allocate towards debt repayment essentially provide you with a tax-free, risk-free return equal to the interest rate on your loan. By prioritising debt repayment, you’re effectively saving interest and reducing debts which helps to improve your net asset position.
- Improved Cash Flow: Paying out debt is essentially like buying back your cash flow. Once the loan is paid out in full, you will no longer need to allocate funds to repayments. Instead, you can allocate that money to further wealth building activities like investing!
- Financial Discipline: Making consistent additional regular repayments instils financial discipline and encourages responsible money management, fostering a healthy financial mindset for the future.
- Achievement: Watching your debts crumble can be immensely satisfying.
Before make an additional repayment, consider this…
Before making additional regular debt repayments, it is important you consider the following:
- Opportunity Cost: By allocating funds as an additional regular repayment towards debt, you are forgoing the ability to invest those funds, which may generate a higher return than the interest cost of your loans.
- Potential Fees: Repaying your loan earlier may result in break fees, penalty fees, deferred establishment fees, or early repayment fees. It’s important to contact your lender to understand these charges before proceeding. These fees could potentially offset the interest savings from early repayment.
- Payment Restrictions: Depending on your loan terms and conditions, there may be restrictions on the amount of additional regular payments that can be made to your loan. This is particularly important with fixed rate mortgages.
- Addressing the Root Cause: Paying off debts with a lump sum addresses a problem in your financial life but may not resolve the cause. If your debt was used for consumption, changing financial habits is essential to prevent accruing similar debt in the future.
- Lose Access to Capital: Once an additional repayment is made, you may be unable to get those funds back. If you need access to the money in future, check if your loan offers a redraw facility prior to proceeding.
- Tax Implications: When you have an investment loan, the interest on the loan may be tax deductible. This means the interest can reduce your taxable income, effectively reducing how much tax you pay. If you pay off the loan faster, you will pay less interest, and therefore your tax liability could increase. Please note, while it is often beneficial to focus on non-deductible debt first, a tax deduction is not a good reason to hold onto debt.
As you can see, there are many benefits of additional regular debt repayments but there are also a number of considerations you need to make before implementing this strategy. You may also want to consider pairing additional repayments with a Lump Sum Debt Repayment to further accelerate the debt reduction process.
