Borrowing against your house to invest can work well - but it's not for everyone, writes Mary Holm.
OPINION:
Q: As the recent International Women’s Day passed, I feel proud that I bought my own home as a single woman, with KiwiSaver, in 2011, age 37 (after reading Get Rich Slow a few years earlier).
I’m on an island suburb near Auckland. It’s an old bach on a section with a current GV of $600,000. It’s not the Ritz, but is safe and warm. I paid $195,000 (a fantastic buy) plus $30,000 improvements. My mortgage is $135,000, that will be paid in eight years when I’m 58.
If I do nothing now but work and pay it off and continue with 4 per cent KiwiSaver and a small share fund, then I will be okay in retirement with about an extra $300 a week on top of super.
But I’m worried that the equity in my house is “dead money”. Everyone seems to have nicer cars and toys than me and I’m very risk-averse. Should I buy an investment property?
A: It sounds as if you’ve been hearing a tired old story. There’s nothing dead about having equity in your house — the difference between the value of the house and your mortgage.
Your equity is giving you a home. Nobody can move you out or tell you how to run things. What’s more, you know that by the time you retire, you will have most of your accommodation costs taken care of. That’s a big deal. There will of course still be insurance, rates and maintenance costs, but they will probably total a lot less than renters and people with mortgages have to pay.
Having equity in your house also gives you a sort of emergency fund. If the need arises, you could borrow against it for, say, a medical expense, a big maintenance cost or a family crisis.
If you borrow against the equity to invest in rental property, you lose that buffer. Still, it’s not necessarily a bad move. Many people do it, and quite a lot do well out of the venture. But some don’t.
An important rule when you invest in anything is: never put yourself in a position where you’re forced to sell.
In the next few years I expect some landlords, facing rapidly rising mortgage payments, and with rental income not nearly covering costs, will find themselves having to sell. And those who bought not long ago might have to sell for less than their mortgage. They have a debt to the bank and nothing to show for it. Gulp!
“Okay”, you might say, “but I will be buying in a lower-priced market.” That’s true, but house prices could well drop much more.
Perhaps we should add another investment rule: whenever you buy any asset whose price is volatile — such as shares or property or collectibles — picture the price falling in the next few years. Will that be difficult for you either financially or psychologically? If yes, don’t buy. You’re “very risk-averse”, so this would definitely apply to you.
Also, don’t overlook all the hassles that can arise for landlords: troublesome tenants, rent not coming in, unexpected maintenance bills and so on. Do you need that in your life?
When somebody tells you that equity in your house is dead money, think about their motives.
It might be a friend skilful and lucky enough to have done well with investment property. They mean well, but you won’t necessarily be able to copy them.
Then there are those who, one way or another, will gain from your buying a rental property. They might be real estate agents, property managers or people who run seminars or advice services who clip the ticket when you buy a property.
They might well get richer from your investment than you do.
You’ve done really well financially. I suggest you relax and enjoy your home and your island paradise. It sounds as if you could afford a few toys, even if it means becoming mortgage-free a year or two later. But before you splash out too much, have a look at the toy owners. Are their lives really happier than yours?
By the way, it’s great to know my book Get Rich Slow helped you. I still stand by what’s in it, but it was published in 2006, before KiwiSaver. My more recent books work better for readers these days.
Q: Silicon Valley Bank failed because they invested in ultra-safe US Treasury securities. I understand why, when interest rates go up, the value of the securities falls. But they are “ultra-safe”. If held to maturity you get your money back plus interest. There is no loss. Can you explain this paradox?
A: It’s a sad story. Silicon Valley Bank prospered when tech and healthcare companies boomed during the Covid pandemic, and many of those companies put money into the bank.
The bank then invested fairly heavily in long-term US Treasury bonds. As you say, they are rock-solid. There is practically no chance the US government won’t repay the money when the bonds mature.
However, since the bonds were purchased, the tech sector’s fortunes have declined, and the bank’s customers started to withdraw money at an unexpected pace.
To give them their money, the bank had to sell some of its bonds. The trouble was, interest rates had risen fast since those bonds were issued at the old, lower rates.
Consider this: if someone offered to sell you a $10,000 government bond that was paying, say, 2 per cent interest, when you could buy newer ones paying 4 per cent, you wouldn’t be interested. But if you could buy the bond at, say, $8000, knowing you would get back the full $10,000 when it matured, you might well buy. The lower price would make up for the low interest in the meantime.
That’s how perfectly safe bonds lose value when interest rates rise. If they will mature soon, their value drops less, because the buyer will get the face value back soon. But if maturity is years away, their value can drop a long way.
Conversely, when interest rates fall, older bonds at what have become higher-than-market rates gain in value.
Back to Silicon Valley Bank. When it announced that it had had to sell some of its bonds at a loss, that spooked the bank’s customers, and more and more decided to withdraw their money, in what became a classic run on the bank.
It seems clear the bank shouldn’t have bought so many long-term bonds. But perhaps its biggest mistake was that it broke another investment rule: diversify. Too many of its customers were in one or two volatile industries.
Q: Not being alarmist, but after hearing of the recent Silicon Valley Bank collapse it crossed my mind that many Kiwis are taking advantage of better term deposit rates these days. How secure would these deposits be if one of our banks was to “tip over” unexpectedly?
I note that most of the banks offer a PIE alternative to a standard term deposit, which I think is held in a trust. Would a PIE deposit be more secure than a standard term deposit?
A: First, the New Zealand Reserve Bank has said our banks are not in a similar situation to the Silicon Valley one. “We are confident that the banks we are responsible for supervising have sound liquidity and funding positions,” it says.
Still, the news from the US could get some readers worried about what would happen if their bank failed.
Currently, under what’s called Open Bank Resolution (OBR), if a bank fails, a portion of all accounts — including term deposits — would be frozen. You would probably get some of your money back after things settle down, but maybe not all of it.
In the meantime, the bank would stay open, and a small amount in each transaction account would not be frozen, so everyone could continue their day-to-day banking.
But what if your money was in a bank PIE, or portfolio investment entity?
PIEs, which include almost all KiwiSaver funds, are run by fund managers including banks. The PIEs you are talking about are either:
All PIEs, whether or not they are run by banks, are not subject to OBR, says a Reserve Bank spokesperson. However, PIEs invest in financial instruments, and many of these types of PIEs invest only in interest-bearing deposits with their own bank. Those deposits would be affected by OBR if the bank failed.
A better choice, if you want to reduce the OBR risk, would be a cash fund that invests in a range of deposits with different banks and perhaps other entities. There’s info on these types of cash funds, including what they invest in, in the Smart Investor tool on sorted.org.nz. Go to Compare, Managed Funds, and then Defensive.
Note, though, that worries about bank failure should diminish soon, when the government guarantee of bank deposits up to $100,000 takes effect. “The Bill will be passed this year and will be operating next year,” says a spokesperson for Finance Minister Grant Robertson. He couldn’t be more specific about when next year.
Q: I had to take a second look at the letter from your correspondent last weekend who wrote about the stupidity of people who didn’t understand the concept of laddering term deposits, and by implication also those who advocate the practice.
I don’t believe that I have ever read such an arrogant and condescending letter in a column such as this, made worse by the fact that, as you pointed out, they totally missed the point themselves.
I can tell you that I have spoken with many people who hold very senior positions in the business and professional world who had neither heard nor thought of laddering their term deposits, but appreciated the idea.
All I can say to your correspondent is: “If you’re so smart then you must be very rich, huh?”
A: Thanks for writing, and for the endorsement of laddering.
Q: My first thought when I read the condescending letter from the second correspondent in your last New Zealand Herald column was, does the writer know that if one approaches a bank with regard to investing, either laddering or not, they can usually negotiate a better interest rate than that listed?
I am often amazed at the number of folk who simply “roll over” term deposits without negotiation.
A: Good idea. First, check what other banks offer in the Saving section of interest.co.nz. If your bank is lagging, point that out to them. Even if your bank is a leader, you still might be able to do even better by asking.
Q: Could you please consider publishing more letters from the genuinely curious wanting to learn more about personal finance, rather than mansplaining boomers, like the one last week commenting on laddering?
There are enough such opinions in every comment section everywhere, and their loud and condescending views already get too much air time. It really reduces my enjoyment of your column.
A: Sorry if that Q&A upset you. However:
One more thing: you’ve made assumptions about the reader’s gender and age. He does indeed have a usually male name, but who knows how old he is? But let’s not have crabby letters from boomers complaining about your unfairness.
More on laddering term deposits next week.
- Mary Holm, ONZM, 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 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.
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