The bankers' 'secret' is not actually hidden, the information, which can save you money, is there in plain sight
There was an excellent book released in the mid 1990s called The Banker’s Secret, written by Marc Eisenson.
Banks weren’t deliberately withholding anything. ‘The secret’ was and remains in plain sight for all who care to take notice of it. And take notice of it we should.
The secret, according to Eisenson, was how banks charge interest on loans and mortgages.
We all know banks charge interest for lending money, but I’m not quite sure if we still understand how that works in practice. I say that because I meet so many people who are disappointed and puzzled to see how little their principal has reduced by when they get their annual mortgage statement every year.
Eisenson’s book showed them it wasn’t enough just to know what their monthly repayment was. They needed to know the impact it was having on them over time.
But Eisenson also revealed what actions they could take to get around the bankers’ secret, which would work in their favour and save thousands in interest payments and, in some cases, cut mortgage terms in half.
For me, knowing how to do that was the true secret revealed in the book.
You see, banks front-load interest payments at the beginning of the loan. While each monthly repayment is for the same amount, if you dig a little deeper, they are very different. And they are different because not every payment is divided into equal amounts of interest and capital.
At the outset, your monthly repayment is made up primarily of interest payments, and at the end, it’s mostly made up of capital payments.
To demonstrate how this works in practice, let me give you an example.
If you borrowed €300,000 over 30 years at a rate of 4%, your monthly repayment would be €1,432.
In year one, interest payments account for c. €991 of that €1,432 payment, and only €441 is coming off the principal.
In year 10, you are still making payments of €1,432 but the structure of the repayment has changed. Interest payments now account for €776 of your monthly repayment and €656 is going towards reducing the amount outstanding.
It will take 13 years before you begin to pay more capital than interest but get this – over those 13 years, you will have paid back €223,430 but your mortgage balance will only have reduced by €88,253; the rest will have gone on interest payments.
That’s the reason why you might look at your mortgage statement every year in disbelief at the amount you still owe.
And on more than one occasion, over the past number of years, I have revealed in this column what those secrets - let’s call them strategies - are, to making less interest payments and/or accelerating the repayment of your mortgage.
They are very simple. l You overpay each month. l You choose a shorter term. l You pay more frequently. l You make lump sum lodgements.
It’s hard to exaggerate how much they can help the borrower save, and it’s not difficult to do either. So, why isn’t every mortgage holder doing it then?
Some say they don’t have the time. But it takes just five minutes. A client of mine did this recently and the outcome was interest savings of €18,106. He saved €3,621 for every minute it took him to set up the standing order, and if you can get a better return, please let me know.
Others are reluctant to make any adjustments for fear there will be consequences for altering their mortgage terms (there won’t) and others say they don’t think they have any extra money to pay.
But someone with a 30-year, €300,000 mortgage, might be surprised to find out, they only need to come up with an extra €1.64 per day if they wanted to reduce their term by 20 months which would also save €12,822 in interest payments.
Other people don’t make overpayments or have shorter mortgage terms, because they want to spend the money on other things, right now.
They don’t get that immediate impact they are looking for, because the savings come at a later date i.e. when the mortgage is repaid in full.
Yes, they know it would obviously be great if they were mortgage-free quicker, but they can’t visualise or don’t know what that impact will be, so they do nothing.
But what they are missing out on, with this mindset, are months, if not years, of not having to make mortgage repayments in the future.
If you want to save money and eliminate what’s probably the biggest expense you will have in your lifetime, there’s no big secret to achieving it - it just takes some effort, a little bit of time, and the know-how, that’s all.
Liam Croke is MD of Harmonics Financial Ltd,
based in Plassey. He can be contacted at email@example.com or www.harmonics.ie