Pay off the mortgage or invest? Photo / 123RF
COMMENT:
Q: It seems to be the perceived wisdom to pay off your mortgage before saving your money elsewhere.
But now that mortgage rates are so low, wouldn't it be better to put your money into, say, a share fund, rather than pay down a 3 per cent mortgage, on the assumption that returns from a share fund will beat 3 per cent, even after fees and tax?
I've recently started a savings plan with Simplicity and wonder if I'm doing the right thing.
A: I, for one, have always said paying extra off a mortgage tends to work better for most people than investing in, say, a share fund.
The argument went like this: "If you pay down a 5 per cent mortgage, that improves your wealth as much as earning 5 per cent on an investment. Sure, a share fund investment might average more than 5 per cent, after fees and tax, over the years. But the return is volatile, and the investment has some risk, whereas mortgage payments are risk-free."
Other advantages of paying down a mortgage include:
• Being mortgage-free sooner puts you in a strong financial position. Your accommodation is taken care of. And if you need to borrow for something, you can usually raise another mortgage.
• You don't have to think about how to invest.
However, a 3 per cent mortgage interest rate does change the balance somewhat.
Although sharemarkets have been really volatile lately, long-term returns should still be well above 3 per cent. So you're probably doing the right thing, as long as:
• Your investment is fairly high risk — because otherwise you're less likely to get a higher return than the mortgage interest rate.
• You can cope with volatility, and won't lower your risk during downturns.
• You're investing for 10 years or more — to reduce the chance you'll be hit by a downturn close to when you want to spend the money.
• You're in a strong position financially, with secure income.
For another argument in favour of your plan, read on.
Q: I'm interested in your thoughts on qualifications to your normal advice around paying off a mortgage versus investing, which seem to focus on the relative uncertainty of returns.
In particular, I'm thinking of the importance of diversification to this decision — one property versus the global economy.
Perhaps an example would help. My partner and I are not currently homeowners but are likely to be in the next couple of years.
If buying today, our plan would be to do a 20 per cent deposit (currently in term deposits) on an $800,000 house. We have an additional $400,000 invested in index and growth funds.
Diversification would be the primary argument in favour of not increasing the house deposit relative to other investments.
In simple terms, we figure our chance of picking a winning house (relative to the statistically average New Zealand house) is only slightly better than picking a winning share! Hence, funds in general, and hence not wanting to "overweight" towards a single property. Interested in your thoughts.
A: You're right that putting all your money into buying a house, or paying down a mortgage, means you miss out on diversification from investing in, say, an international share fund.
You also miss out on learning about how the markets rise and fall — useful knowledge, as recent events illustrate!
Because of that, back before KiwiSaver started in 2007, I used to suggest people do a little share-fund investing alongside paying off their mortgage.
These days almost everyone is in KiwiSaver. And if they're in a medium- or higher-risk fund, they often have a fair bit in shares.
But if you want to have more, I won't argue — especially in these low-interest times — as long as you can tick everything on the checklist above.
Q: I would like your opinion on the following situation. My daughter (47) and her fiance (53) have good permanent jobs and have bought their first home together.
My daughter put down a substantial deposit (she was previously mortgage-free) and he pays the mortgage, which he intends clearing before retirement. She has KiwiSaver but he has not joined up, preferring to pay more off the mortgage.
My daughter (and I) feel he's missing out on the advantages of this Government-supported retirement saving. He moved to New Zealand permanently early last year and will have a pension from his homeland in due course.
Should he join KiwiSaver now, and at least put the minimum in, or continue to put all he can into the mortgage?
A: I wonder if your son-in-law-to-be (SILTB) is keen to get rid of the mortgage to even things up with your daughter — so that each has paid for, say, half the house. He might find the current situation a bit uncomfortable, and that's understandable.
However, I do agree with your daughter and you. It sounds as if SILTB is an employee, in which case every dollar he puts into KiwiSaver would be roughly doubled by the Government and his employer.
Even if he's self-employed, he can contribute $1043 a year and the Government contribution will boost that by 50 per cent.
Add the current low mortgage rates to the picture and being in KiwiSaver is a pretty clear winner over making extra mortgage payments.
Still, I suggest he puts only enough into KiwiSaver to get the incentives — 3 per cent if employed and $1043 a year otherwise.
Beyond that? While the correspondents above prefer investing, there's still nothing wrong with killing off a mortgage quickly, especially when approaching retirement.
Note for SILTB: If I were you, I might resent my partner and their parent telling me what to do with my finances! But perhaps let them win this one. It's a pity to miss out on free money.
Q: My wife and I have reached the golden age with $100,000 or thereabouts in KiwiSaver in a growth fund, $500,000 net equity in our home in Hamilton and cash balances of $10,000 for emergencies.
My wife is no longer working and I am still able to work as an IT contractor from home. This brings in about $4000 a month. Our monthly budget requires $4000 a month.
Obviously, our KiwiSaver has taken a hit, but has recovered about 35 per cent of what it lost through Covid-19.
We are planning to redecorate/refurbish our house before selling it within six months. This will require funds from somewhere.
I believe we would benefit by taking up our bank's mortgage holiday for six months, then using that saving to partially fund the upgrade.
The cost of the money for our project will be at the lowest bank interest rate available and keeps our KiwiSaver funds in place. Your comments and advice are invited.
A: This is a new twist on the mortgage versus investing theme. You've obviously got a mortgage and chosen not to use your KiwiSaver money — now that you can access it — to reduce the loan. Now you're considering taking that one big step further, by adding to the mortgage.
Make no mistake about it, a so-called mortgage holiday is actually a mortgage addition. You'll have to make bigger payments in future or extend the term of the loan or both.
But that's not necessarily bad. It boils down to whether you can make a higher return on your KiwiSaver money over the next six months than the rate you're paying on your mortgage.
It's a gamble. You might do brilliantly. But as the past couple of months have shown, bad stuff can happen to growth funds over short periods. And we could be in for further falls.
Work through a worst-case scenario. How would you feel if your KiwiSaver account halves or worse while your mortgage balance is growing?
Maybe that would be tolerable. Perhaps you won't need to spend the KiwiSaver money for years, so there's time for it to recover. Or perhaps you're planning to trade down to a cheaper house, thereby freeing up more retirement savings.
If you could cope, go for it. And good luck!
- Mary Holm is a freelance journalist, a seminar presenter and a bestselling author on personal finance. She is a director of Financial Services Complaints Ltd (FSCL) and a former director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary's advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to mary@maryholm.com. Letters should not exceed 200 words. We won't publish your name. Please provide a (preferably daytime) phone number. Unfortunately, Mary cannot answer all questions, correspond directly with readers, or give financial advice.
This recovery is making us sweat, but that might be a good thing in the long run.