Should you keep mortgage payments high when interest rates drop? - Nadine Higgins

Before committing to keeping your fixed mortgage repayments high when interest rates come down, it's best to ask yourself a few questions. Photo / 123rf

THE FACTS

• When locking in a lower mortgage rate, consider if you should keep repayments the same.
• Offset or revolving credit accounts can provide flexibility and save interest, but require disciplined use.
• Preserving liquidity offers protection against unforeseen financial challenges.

When you lock in a new, lower, mortgage interest rate (hooray!) the question the bank often asks is whether you want to leave the repayments the same.

If repayments at higher interest rates weren’t completely crippling you, it might seem like the answer is obvious – if more goes towards paying principal, you’ll save on interest and get mortgage-free faster, and how can that be anything other than a good thing?

But before you say “yes” and pat yourself on the back for your industriousness, I want to give you a few things to consider, to ensure it’s the right decision for your circumstances.

If there’s anything the twists and turns of my life have taught me – redundancy, self-employment, a pandemic, an unexpected pregnancy – it’s that having a financial safety net is essential, or you can very quickly find yourself sailing too close to the wind.

The problem is, you often don’t realise just how crucial one is until you really, really need it – or rather, you don’t prioritise building one until you experience the precariousness of your financial position without one.

What does that have to do with your mortgage decisions?

Well, whether you have a sufficient safety net (or, as I like to call it, an ‘oh s***’ fund) is one of the first questions to ask yourself before you commit to keeping your fixed mortgage repayments high when your interest rates come down.

If you don’t, I’d suggest the answer is ‘no’ – you don’t have the financial resilience to commit to paying the bank money you may not be able to get back. When you most need extra funds from the bank is precisely the time when they’re most likely to say ‘no’. If you lose your job, for example, you become a poor candidate for lending at the exact same moment you have the greatest need for it – even if you got an A+ for paying the bank more than required just a few months prior.

Many people assume your emergency fund needs to be cash in an account or under the mattress but you can kill two birds with one stone if you structure your mortgage appropriately. Some banks have different brand names for them, but the products – an offset account or a revolving credit account – principally fulfil the same function (with some different benefits and drawbacks). They allow you to put cash against the debt, meaning you don’t pay interest on your savings balance, but – and here’s the crucial bit – you can still access that money at the drop of a hat, without having to ask the bank for permission. That can give you flexibility, while also saving you money on interest (which in turn should free up more cash to put towards repaying the mortgage!)

But – and there’s always a but with personal finance – neither function well as either a mortgage repayment strategy or an emergency fund if you simply use that money as a giant slush fund to dip into any time you see something you want to buy. If money simply washes in and out every time you repay your credit card each month, you’re using that account in the most expensive way you can. That is, paying the floating interest rate, which is higher than fixed rates, for little gain. Yes, you’ve had the money sitting there offsetting interest for a month while you put everything on your credit card, but once that’s repaid you’re back to square one (or, arguably, a few steps behind that, given the research shows credit cards prompt us to spend more).

The point is, if you don’t have a good handle on your spending, a plan or a goal to work towards, “efficient” mortgage structures can enable your poor financial management, rather than speed up the pace at which you repay debt. There is a reason why some call them “revolting credits”!

So, if your finances are in disarray, should that prompt you to commit to higher fixed repayments instead, to force yourself to save? Maybe, but there are a few other things I’d want to know first.

Depending on your situation, higher repayments can protect you from yourself and save you money without introducing too much risk. Photo / 123rf

For example, how tight were things while you were paying interest rates in the high 6s or low 7s? Are you likely to need to go to the bank for any extra lending for anything else, like a rental property? How stable is your income? What plans do you have to start a family, or switch jobs? How quickly can you build an emergency fund of three to six months of (no-frills) living expenses?

If you have your emergency fund sorted, you’re in a low-risk, stable job, you paid higher rates easily, you have no changes or big expenses planned, and you know you’ll just spend any extra money that hits your account, higher repayments will protect you from yourself and save you money without introducing too much risk.

But still, I’d encourage you to think about your financial resilience (and ideally, fixing your relationship with money!)

Overpaying your mortgage might save you interest, but preserving liquidity could save your bacon (and if you could do it right you can have it both ways!)

Perhaps I still have pandemic PTSD, but no one knows what’s around the next corner, so I like to keep some cards up my sleeve to deal with whatever the next “unprecedented” event is.