Finding the right home for your money

By MARK FRYER

As with any investment, if you're putting your savings into a mortgage fund it's best to ask the questions beforeparting with your money. Among the issues to look at:

* FEES: Given that the returns are likely to be modest, mortgage fund investors should aim to keep fees to a minimum.

Most mortgage funds don't charge an upfront fee, but some do, and even a small initial charge will eat up a large proportion of the slender returns on offer.

Avoid the expense, either by choosing a fund without an initial fee, or by investing through one of the various managed fund brokers who refund those fees.

Several mortgage funds charge an exit fee of up to 2 per cent when investors withdraw, though typically that charge is waived once the money has been in the fund for a year or two.

As well as entry and exit fees, look at the ongoing fees, which will take some of your potential return every year.

Information on those charges, known as the management expense ratio, is available from online sources such as Morningstar and FundSource.

* INVESTMENT STRATEGY: Some mortgage funds have the vast majority of their money in residential mortgages, but others have a high proportion in higher-paying - but potentially riskier - commercial loans.

A look through the investment statement can also provide an idea of the level of security a fund requires before lending out its money and whether it invests in things other than mortgages, such as government stock.

* PRACTICAL ISSUES: How big is the minimum investment - it can be anything from $500 to $10,000.

Will the fund manager automatically reinvest your earnings, if that's what you want, and does it offer a regular savings plan, so you can boost your investment by adding relatively small amounts at regular intervals?

* STRUCTURE: Mortgage funds are typically set up either as unit trusts or group investment funds. The difference matters, especially when it comes to tax.

Unit trusts pay tax on their income, then pay what's left to their investors, along with imputation tax credits. For a taxpayer in the 33 per cent bracket that means there is no more tax to pay. Taxpayers on the 39 per cent rate have another 6 per cent to pay and those on 19.5 per cent can use the imputation credits to reduce the tax on any other income, effectively reducing the tax rate on their mortgage fund returns to their own personal rate.

All fine in theory, but it does mean that 19.5 per cent taxpayers have to file a tax return to use the imputation credits, and they may not be able to take full advantage of them if they don't have enough other income.

With a group investment fund, tax can be deducted at each investor's own rate, before the money is paid out, in the same way as interest on bank accounts is taxed.

The BNZ, which offers mortgage funds using both structures, says its unit trust, the Mortgage Investment Fund, is more suitable for taxpayers in the 33 or 39 per cent brackets while its group investment fund, the BNZ Mortgage Distribution fund, is better for those on the lower rate.

Morningstar

FundSource