The $100,000 dilemma:
Wipe out your mortgage debt or buy a better home?
With inflation still at uncomfortable levels and interest rates unlikely to fall anytime soon, there’ll be more than a few mortgage holders who wish they had $100,000 at hand to bring down or wipe out their home loan debt.
But is using a lump sum to pay off your home loan early the best financial strategy, even when rates are skyhigh?
By making a lump sum payment, mortgage holders can significantly bring down the amount of interest they’re paying on their loan. But a lump sum might be better used as leverage for an investment property purchase, which could in the longterm yield better results, or even be used to buy a better home.
OneRoof asked mortgage brokers and housing market experts for their opinion.
Mortgage broker Campbell Hastie has been quite surprised at the cash savings some of his clients have accrued post-Covid. “We’re noticing lots of people have got some cash that they’ve been sitting on. They’re now putting it into the mortgage to take the top off the increased interest rates they are facing,” he said.
“It’s really the amount that’s most interesting. It’s not just five or 10 grand here and there. Sometimes it’s 50 to 100 grand that they’re throwing in.
“They’ve literally been sitting on it. Squirrelling it away for the rainy day. The rainy day hasn’t really arrived, but interest rates have gone up. So they’re taking the opportunity to soften the blow. We’re seeing lots of restructuring of mortgages as a result.”
Mortgage broker Gareth Veale, of EasyStreet Mortgages, has seen the same scenario. “I have seen a lot more parents willing to chuck cash against their children’s lending,” Veale said. “One, for example, came to me and asked for advice on what was the best way to pay off his daughter’s mortgage.” The daughter would repay her father at a rate lower than the 7% the bank charges.
Veale says mortgage holders who do have rainy-day savings should consider using revolving credit or offset mortgages. These allow homeowners to reduce the mortgage, but retain the ability to redraw the money should that rainy day eventuate. “If you pay off the mortgage you are at risk of not being able to get that money [back],” he said. Another option for homeowners with chunks of savings is to consider “leveraging” that cash into a rental property, said Veale. “It can make sense for people to become property investors.” However, that only works if you have sufficient income to pay another mortgage, with rental income alone unlikely to cover payments. “Property investment isn’t necessarily for everyone. You have to have the income and the time to be able to top up your investment,” he said.
Opes Partners economist Ed McKnight cautions against using lump sums to trade up to a better home.
“The big risk is you get to retirement, have a really expensive home, no mortgage, but little else,” McKnight says.
“We recently had an investor tell us he was very worried about his parents, who have got a $1.7m property, no mortgage and some KiwiSaver. They’re going to have a pretty limited lifestyle off the pension and the KiwiSaver,” McKnight said, noting they would have to sell the property and buy something cheaper if they wanted to release money to fund a better retirement.
“If you’ve got the ability to weather some of those higher interest rates and it’s not putting you in stress, creating assets outside the family home [with any surplus money] can be a good idea. It could be shares, it could be funds, it could be other investment properties.”
Anyone who wants to use the cash for a rental property should structure the purchase with care for tax reasons, McKnight said.
“An accountant would say ‘pay off your own mortgage [with the lump sum] then borrow that money back, because then it will be tax deductible’. That’s typically what investors would do.
“Your mortgage on your own home is not tax deductible. Your mortgage for investment property is tax deductible.”
Homeowners not interested in taking on investment properties will still get a good return by paying down the mortgage, McKnight said.
“At the moment, your interest rate might be 7%. So effectively you save 7% on mortgage costs. It’s the equivalent of a 10% term deposit rate [after tax]. So paying off your mortgage is actually quite a sensible thing to do, unless you can get an extraordinarily good return somewhere else.”