Forgotten art of paying down mortgage
The temptation of easy money is often too much for Kiwis, but it means staying on the hamster wheel.
Mortgages are leaving many homeowners financially squeezed. With mortgage rates topping 7 per cent for many people and the size of mortgages having grown substantially over the past 10 years, the pain is biting.
That has encouraged some people who can to double down on paying the mortgage. Every extra dollar paid back over the minimum is a step towards mortgage freedom.
Slowly paying the mortgage off has become a bit of a forgotten art. Since the 1990s, when the “housing market” became a “property market” and investing took off, the concept of paying down the mortgage has been replaced with ideas such as spare equity and remortgaging to buy cars, pay down debt or do renovations.
Easy refinancing means some people never pay off their homes. They renovate, take holidays, buy Teslas or trade up instead. Their mortgage becomes a giant hamster wheel. That thought brings back memories of the now-infamous 2013 BNZ “Work Til You Die” TV adverts.
It’s no doubt impossible for a lot of people to overpay their mortgages right now, although a budgeting exercise can help some. They may have to wait until mortgage rates start to drop before they can begin to pay down the mortgage.
But for those who can find some spare cash, every extra dollar paid into the mortgage saves 7 per cent in interest, which is a lot more than that money would be receiving in a savings account after tax.
Financial adviser Tim Fairbrother of Rival Wealth says New Zealanders are very good at taking out a mortgage and then holding it for the entire 30-year term. “When you do the figures on that, over 30 years, you pay another $500,000 or so [approximately] in interest on a $500,000 mortgage. So you’re actually paying double, which isn’t a great discipline.” Upping repayments is the opposite of the hamster wheel.
Fairbrother says many people have a plan to downsize their home when they retire, to release capital to live on. The trouble with that is they have all their eggs in one basket and are reliant on house prices going up. If ever there was a lesson in the risks of that, it’s the price falls since the peak in 2021 at the same time as inflation is biting.
Paying down the mortgage is diversifying away from the exact risk that the past two years have highlighted, Fairbrother says. “Two years ago, clients were saying, ‘Why wouldn’t I borrow a whole lot more now? Money’s so cheap’. Well, now we’re finding out why that was a bad idea. Money’s not always going to be cheap.”
Before attacking the mortgage, make sure you build a “rainy day” fund, says Fairbrother. “Every financial adviser tells you to make sure you have three months’ expenses to cover unexpected [costs].”
In the background, everyone should also be paying sufficient funds into KiwiSaver to get the Government tax credit, he adds. Only then should you focus on extra mortgage repayments.
The real sweet spot for doubling down on the mortgage is when the children leave home. Living costs tend to fall when that happens.
Once the home is paid off, it frees up money to boost retirement investments. Fairbrother is a property investor himself, but recommends clients have a variety of investments, including funds.
If the mortgage can be paid off by the age of 55, you have 10 years of saving to build up a nest egg for retirement. “How do I do that? By taking the $3000 a month you were paying into a mortgage and investing it in a diversified fund that will build up over time with compound [returns],” says Fairbrother. “If you put $360,000 in over 10 years, it should double to $720,000, in theory, over that period of time.”
Those struggling to meet minimum mortgage payments currently may have to wait until interest rates start to drop, which could be from mid-2024 on.
A great way to tackle the debt in that scenario is to keep repayments at the same level when interest rates drop. The difference between the new mortgage repayment and the old one will reduce the outstanding capital.
Another way to make a dent in the mortgage is by changing from monthly to fortnightly repayments that are half of the monthly sum. The trick here is that there are 26 fortnights in a year, which means making the equivalent of an extra month’s repayments.