Ask Paul

Debra is concerned about a mortgage relief rumour, so …

QHi Paul. My family and I bought and moved to our new Gold Coast home in April 2018. Our mortgage is $585,000 and we have a five-year fixed-interest rate of 4.45%.

We decided to go with a fixed-rate loan, thinking on the safe side that if interest rates go up we would still be paying the same weekly repayments (around $671 a week). We both make extra repayments. My wife contributes $200 fortnightly while I contribute $75 weekly. I paid off my $10,000 car loan about three months ago so the only debt I have is our mortgage.

Two years later – and because of the current pandemic – interest rates have fallen everywhere (to a low rate of 2.27% on a three-year fixed term).

Thankfully, my wife and I are still working full time. We tried to negotiate with my lender but sadly they declined our request, informing us that under the contract we need to finish the term, which has three more years remaining.

My question is, will it still be worth making extra repayments even though our home loan fixed rate is still high? I am thinking of stopping our extra repayments and saving the money, and once we renew our loan term in three years and get a lower fixed rate, that will be the time to make extra repayments. When the term ends, is it also worth going with another fixed-rate term or switching to variable?

I am sorry to hear you are locked into the higher rate, Victor, but you did the right thing talking to your lender. Do check what the penalty is in your contract. It may be so high that it makes no sense to change, but bank contracts do vary.

What you also need to know is how your extra payments are treated. Is the extra money reducing the size of your loan and hence the amount of interest you pay? If so, it would be a no-brainer, as effectively earning 4.45% tax free on any savings or extra repayments would be great. Check with your bank.

Once you understand the conditions around extra repayments, you can make a call. But in a worstcase scenario, I agree, keep on saving so you can reduce the size of your mortgage in three years.

For about 40 years I have been advising people to avoid fixed-rate mortgages. I got this wrong in the late 1980s as interest rates soared, but since 1990 it has been a one-way street with falling rates. I suspect my preference in three years will be to go with the lowest-cost variable loan you can get. But as we sit here in the middle of a pandemic, I’m going to reserve judgement. But I’d love you to drop me a note in three years and we can revisit the issue.

QHi Paul, I have heard a rumour that if you ask your bank for the six-month break from your mortgage because of Covid-19, and then you need further assistance down the track, this will not be available as you will already be considered “in default”.

My young friend has recently purchased a unit; but he now finds himself unemployed and with no tenant. The sixmonth break seems a good idea, but now he is not so sure because of the rumour. What are your thoughts?

There are some cracking rumours going around, as is always the case when we are a bit on edge and uncertain.

The very best thing your young friend can do, Debra, is to go straight to the source and have a good discussion with the bank. All too often, a lender is the last person we talk to. At times I can understand this, but if we look at the bank’s position, your friend has quite a bit of power. The bank does not want to foreclose on him at any stage. In this market, a mortgagee sale is likely to see the bank losing money. It would hate that.

In particular after their bashing at the royal commission, banks evicting people and selling them up would be a disaster for them during a pandemic. So I’d get him to set out all the facts, including his income from JobSeeker or JobKeeper if available to him, and have a conversation with his bank about the help available and what happens after the six months.

I am sure he will find that an open, co-operative attitude to the problem will give him the best chance of a positive outcome.

QHi Paul. I borrowed $296,000 two years ago to buy my own home. After lots of extra repayments I have $111,000 remaining at an interest rate of 2.88% with $540 fortnightly repayments. Ignoring offset, this would effectively be repaid in nine years. I also have an investment property with $271,000 remaining over 27 years at 3.09%.

I have $10,000 to make a lump sum repayment on one loan. According to a loan calculator, the lump sum repayment on my home would save $2794 interest over the remaining life of the loan, but it would save $12,498 over the remaining life of the investment loan.

We often hear it’s best to pay non-deductible debt first, but is that always the case? In this situation, would it make more sense to pay $10,000 off the investment property?

Good question, Michael, and I am very impressed that you have done a solid analysis. The key is here is the best result for you today. And this depends upon your tax rate. If you earn between $37,001 and $90,001, including the Medicare levy, you will pay 34.5% tax.

Your point about non-deductible debt is spot on. With your home, the 2.88% costs you 2.88%. But with the deductible interest on your investment property, your real rate is 3.09% less your tax rate.

So if you are in the most common tax bracket, the real cost to you of your investment loan is 3.09% minus 34.5%, meaning the investment loan is costing you about 2%.

This will differ if your income is higher or lower. Above $180,001, for example, you would pay some 48% in tax, making deductible debt even more attractive. So add one more number to your calculations: your tax rate. Then I’d suggest you pay off the more expensive loan. Either way, I’d pay this into an offset account, if possible, giving you access to your money.