I am a 38-year-old sole parent of two children. My ex-husband is now extremely disabled and cannot contribute at all to the children.
I have a good fulltime job earning $52,000. My income is unlikely to increase as I would prefer to reduce my hours as my pay increases. I get family tax credits and an accommodation supplement and manage my finances carefully to have no debt other than my $46,000 student loan and mortgage.
If I sell my tiny 60sq m house, and buy a slightly larger home in a safer area, my mortgage would increase by $200,000.
Mortgages of $450,000 seem common now, but it's massive and it scares me. It requires higher repayments (although my accommodation supplement would increase to partially counter the increase) and a 30-year term (as opposed to my current 18-year term). But it would be doable with careful budgeting. It could also be an opportunity to really improve our lifestyle.
Any advice would be much appreciated.
A mortgage of close to half a million dollars is indeed scary. For those who are not in mortgage land, the monthly payments on a 30-year $450,000 mortgage at 5 per cent are $2416.
And if the interest rate should rise to, say, 7 per cent, the payments would be $2994 — or nearly $36,000 a year. That's huge. I'm not saying rates will rise. Nobody knows. But everyone taking out a mortgage should consider how they would cope with a rate rise.
It's always wise in these situations to work through a worst case scenario. For example:
• What if mortgage rates rose? You could perhaps work longer hours.
• But what if you lost your job? Hopefully you could get another one easily.
• But what if you couldn't get work for a while? You probably have a good track record for paying your mortgage, so the lender is likely to let you reduce or suspend your mortgage payments for a period.
• But what if even that didn't work, and everything went horribly wrong? You could trade back down to a cheaper house. That's not appealing, but it wouldn't be the end of the world.
If we take a step back and look at what you're proposing, it's not as if you would be simply running up debt. At the same time, you would acquire a better asset. So you wouldn't be worse off, just in a somewhat riskier situation.
There are two factors that convince me that you should go ahead with your plan. One is the very fact that higher mortgage payments scare you. You are clearly responsible with your money and have no high-interest debt. You'll manage.
Also, I don't like the idea of a solo mother with two children living in a part of town where they don't feel safe. If you can get yourself out of there, do. Being a solo mum isn't easy. There's a lot to be said for moving to a more pleasant environment.
One last thing: I strongly suggest you sell your current place before committing to buy the new place — or else buy on condition that you can sell for at least a certain price. You don't want to find your mortgage has grown by much more than $200,000.
Winning and losing
Is using KiwiSaver to buy your first house a wise long-term financial choice? Surely you would be better off borrowing from the bank. You gain a building but your earnings from KiwiSaver are reduced.
You're quite right that you gain and lose by withdrawing from KiwiSaver to buy a house. But do you lose more than you gain?
Let's start by assuming you have a big enough deposit — without your KiwiSaver money — that a bank would lend you the rest to buy a house. That means you have a bigger mortgage than if you'd made a KiwiSaver withdrawal.
You would be paying, say, 5 per cent on that extra mortgage money. Meantime, would you be earning more than 5 per cent on your KiwiSaver money — so that you would come out ahead?
We need to make a distinction here between:
• New money that you're contributing into KiwiSaver.
• Old money that's already in there — the money you contributed last year and the year before, back to when you first joined.
When you're contributing new money, it's boosted each year by the annual tax credit and — if you're an employee — by employer contributions.
Those boosts mean that an employee's own contribution is roughly doubled. And for non-employees putting in $1043 a year, their contribution is multiplied by one and a half. That's what makes KiwiSaver so powerful, and pretty much impossible to equal in any other investment with comparable risk.
But once your money is old, it grows by whatever returns your fund manager produces.
In a typical year, returns after fees and tax will range from about 2 to 5 per cent on a lower-risk fund, and from about minus 5 to 15 per cent in a higher-risk fund.
So getting back to our question, is that return more than the 5 per cent interest you're paying on the extra mortgage? That depends on your KiwiSaver fund, but in some years yes and in some years no. The two amounts might average about the same.
Given that — in any case — many people don't have a big enough house deposit without their KiwiSaver money, your question is theoretical for most people. If they want to buy a house, they have to withdraw KiwiSaver money. And that's probably not a bad move.
Which leads us to a related question …
I thought KiwiSaver was meant to help improve New Zealanders' savings habits — not to enable more people into long-term debt.
I'm 49 and my mortgage will be repaid in another 10 years. I could be mortgage-free now if KiwiSaver were able to be used to repay a mortgage. And I would be able to save more for the next 16 years.
Surely enabling someone to pay off their mortgage is more beneficial to their long-term wealth than enabling them into long-term debt? So why does KiwiSaver enable us into long-term debt but not out of it?
There are two issues here. The first is whether you should be allowed to pay off your mortgage with your KiwiSaver money.
The second is whether people should be allowed to withdraw KiwiSaver money to buy a first home — which you call enabling them to take on long-term debt.
On the first issue, for many New Zealanders, their goal at retirement is to have a mortgage-free home and some savings.
It could be argued that it doesn't make much difference whether you:
• Concentrate on paying off your home first and then start on building your savings.
• Work on both at once, as under the current system.
You say you would be better off with the first option. But not necessarily. This is basically the same question as in the previous Q&A: Is paying down a 5 per cent mortgage better than investing in KiwiSaver and earning about 5 per cent on average? And the answer is the same: sometimes yes, sometimes no.
What's more, with the first option you miss out on diversifying across a wide range of assets over the years. And that diversification reduces your risk. If one type of asset loses value, others are likely to offset that. So the second option is probably better.
In the early days of KiwiSaver, people actually could divert their contributions to mortgage repayment, but I presume the Government realised that wasn't a great idea and it was soon stopped — except for the tiny number of people already using it.
Moving on to the second issue, your wording about "enabling people into long-term debt" is a bit misleading. If KiwiSaver helped people get into high-interest credit card debt, that would be terrible. But not all debt is bad. Helping people to buy a first home, which will almost certainly rise in value over time, is quite different.
It's a bit like our first Q&A today. You're adding debt but you're also adding an asset. In most cases, you're not worse off, and quite possibly better off. The question remains, though, should KiwiSaver be used for home purchases? Some experts say no — the scheme should be used only for retirement saving.
But I've always supported KiwiSaver first-home help. For one thing, it makes the scheme more meaningful to the young.
Also, if we couldn't use KiwiSaver to buy a home, many people would probably make that purchase later in their lives. At retirement, they would have more in KiwiSaver but probably still have a mortgage, so they would use some of their savings to pay off the home loan.
That would leave them in much the same situation as they are under the current system, except that they bought a home later. Is that a plus? True, they would have more diversified savings for longer. But they wouldn't own their home, and home ownership has many non-financial advantages.
Even under the present rules, many people struggle to get into home ownership. In the 1950s to late 1980s, the average New Zealand house price was two to three times the average household annual income. Now it's more than six times, and in Auckland more than nine times.
Having said all that, everyone with a mortgage should put only enough into KiwiSaver to get all the incentives — 3 per cent of your pay if you're employed, or $1043 a year if you're not. Beyond that it's a good idea to put extra savings into paying off your mortgage.
If you had a lump sum — for example, $200,000 — to invest in an index fund, would you invest it wholly or drip feed (say, $500 to $1000 a month) to take advantage of dollar cost averaging?
For the benefit of others, dollar cost averaging works with any investment whose value goes up and down, such as a balanced or growth fund — in or out of KiwiSaver. It would include the index fund the reader is interested in.
With dollar cost averaging you invest the same amount regularly — perhaps monthly or every payday. That means you'll buy more units in the fund when they are cheap, and fewer when they're expensive.
That brings down your average price.
It works really well — whether the investor realises or not — with investments like KiwiSaver, where you drip feed money in.
But the downside in your situation is, that in the meantime, you have lots of money probably earning a pittance in a bank term deposit, when it could be earning more on average in the index fund.
I suggest you compromise. Drip feed equal amounts — $16,667 a month — into the index fund over a year, rather than the many years you are proposing.
- Mary Holm is a freelance journalist, a director of the Financial Markets Authority and Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. Her website is www.maryholm.com. 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 firstname.lastname@example.org or Money Column, Private Bag 92198 Victoria St West, Auckland 1142. Letters should not exceed 200 words. We won't publish your name. Please provide a (preferably daytime) phone number. Sorry, but Mary cannot answer all questions, correspond directly with readers, or give financial advice.