Okay, so now we know how to get a cheap loan with any discounts available to us. And we know that the longer we are in our loan that further discounts may become available as we build equity and become more valued by our bank due to our lower lending risk profile.

The next step is making sure to avoid the most common mortgage mistakes. Individually or in combination, they can be a major stumbling block to your goal of mortgage freedom.

The traps are out there — so you must know what they are and how to avoid them!

Your bank is very happy when you do the thing I’ll describe below, because they all add up to keeping you in your home loan longer.

 

Avoid the debt consolidation trap

Consolidating your debts to a lower single repayment is usually a good idea, as long as it is done the right way and as long as you don’t do it over and over again.

The lowest interest rate loan you are likely to have is your home loan. Personal loans, car loans, credit cards and store cards will almost always be at a much higher interest rate. It is very attractive and financially sensible to increase your home loan to pay out those debts and then have one single lower monthly payment to think about, as long as you avoid these errors.

 

Error 1 – paying the new minimum repayment

Personal and car loans usually have a 5-7 year loan term. When you pay them out with your home loan (i.e. consolidate) you are borrowing money over a 30 year period. As a result you may end paying a lot more interest than you would have.

Example: minimum repayment trap

Let’s say you owed $10,000 on a 12% personal loan over 5 years. Your repayment would be $223 per month and you would pay a total of $3,344 in interest over the 5-year term.

If you decided to consolidate this personal loan by increasing your home loan by $10,000 at 6% and paying the personal loan out, your new home loan repayment would increase by only $60 per month.

On the surface that looks great – because $223 minus $60 is an extra $163 in your pocket each month.

But here’s the trap: if you did only pay this new minimum repayment, you would end up paying $11,596 in interest – or $8,252 MORE. This is because you are now paying the personal loan over 30 years instead of 5 years.

So if you do pay out other debts with your home loan, keep your repayments where they were already.

In this example, if you kept paying $223 per month (instead of the $60 per month extra which is the minimum requirement) you would end up saving $1,354 in interest on the personal loan and pay it off 8 months sooner.

 

Error 2 – taking on more debt

When you consolidate your debts you will see your repayments fall and extra money in your pocket every month. Don’t be tempted to start borrowing again just because you now feel you can afford it.

Avoid The Debt Consolidation Trap

This happens a lot with credit cards. People get in over their heads in credit card debt (very easy when the bank keeps sending out limit increases), so they add this debt to their home loan to get themselves out of trouble. But old habits take over and the credit cards start rising again — it’s a downward spiral that could trap you in debt indefinitely!

 

Key Point: To avoid both these traps, keep your repayments up to where they were before you repaid or consolidated your other loans. Instead of falling behind you will accelerate your home loan and get the best outcome.

 

Your goal – build both your equity and your cash flow

Becoming mortgage free faster means that you need to grow the equity you have built up in your home — this is because you will later use the equity you have built up to create additional sources of cash flow to accelerate repaying your home which I will discuss later.

But if you have a lot of other debts your cash flow will be lower which will make it harder to build equity in the first place. For this reason it is usually worthwhile sacrificing some equity by consolidating your debts to improve your cash flow so you can then pay your loan down faster.

For many people the first thing we do is consolidate their debts into a single, cheaper home loan which frees up hundreds of dollars a month. Then we look at directing that extra money into the new home loan. In that case they are definitely better off and moving much faster to becoming mortgage free. But if they start using the extra money to borrow on their credit cards again, this is the opposite of becoming mortgage free.

If you start treating your home loan like an ATM you’ll be going backwards.