Slashing your debts

Q. You gave some advice in a recent column re fixed-rate mortgage penalties.

As far as I know, the standard terms for all the main banks is that you are allowed to repay 5 per cent extra on a fixed rate without penalty, per annum.

If you pay more than the 5 per cent, you are then only penalised if the interest rates go down. I understand that in the present market of rates going up, you wouldn't be charged the penalty.

A. Broadly speaking, you're right.

I did say, two weeks ago, that lenders are likely to let borrowers off the penalty in these days of rising interest rates - because they can then lend out the money again at a higher rate. But the situation is more formalised than when I last inquired.

To get more detail on this, I surveyed the major banks by email. The following responded: ANZ, ASB, BankDirect, BNZ, Kiwibank and National Bank.

All of them, except ASB/BankDirect, generally allow extra repayments of up to 5 per cent a year without penalty, but there are a few complications.

At ASB/BankDirect, there's no 5 per cent cut-off. Instead, you can repay up to $500 extra a fortnight or $1000 extra a month without penalty.

BNZ allows the 5 per cent repayment without penalty except on its Classic home loans. National allows it, but charges $100. And ANZ allows the repayment but with a maximum of $10,000 a year.

To add to the complexity, BNZ applies the 5 per cent to the original loan amount, ANZ applies it to your balance at the start of the fixed-rate term, National applies it to your current mortgage balance and Kiwibank applies it to your balance on the most recent anniversary of getting the loan.

What's more, some banks give you the option of making the extra payment as a lump sum, while others accept it only if spread out over the year.

But that's not a big deal. If your lender doesn't accept lump sums, you can always keep the money in term deposits and drip feed it into your mortgage.

What happens if you make extra repayments above the 5 per cent and other thresholds - which might happen if you received a legacy or redundancy payment, or if you sold your property within the fixed-rate period and didn't transfer the mortgage to a new property? If interest rates are rising, all the banks will sometimes waive the penalty - which they call anything from a "charge" to "adjustment" to "recovery". And, as it happens, from now on they will have to give at least some relief when rates are rising, under the provisions of the Credit Contracts and Consumer Finance Act 2003, which took effect yesterday.

When borrowers repay loans, mortgage lenders and other credit providers "can charge the consumer no more than the unpaid balance on the contract, plus a fee to compensate the credit provider if interest rates have changed", says a summary of the Act prepared by the Ministry of Consumer Affairs. The fee "must be a reasonable estimate of the credit provider's loss".

And when interest rates are rising, a lender would usually be hard-pressed to claim they were losing from early repayment of a fixed-rate mortgage.

It's a different story, of course, when mortgage rates are falling and that will happen again, although who knows when?

Early repayment penalties will still have to be reasonable but the penalty could feel like a kick in the guts.

That's why many experts recommend taking a combination of fixed and floating rate mortgages. You can then direct extra repayments to the floating portion, generally without any penalty.

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Q. I think that you gave valid advice in your first answer last week. But I get the feeling the writer would be much better off just sticking with the property portfolio and living from the rental/lease income.

When I do some simple sums on the properties involved: $0.5 million coastal property (approximate rent income say $15,000); two city apartments (approximate rent income combined $40,000); selling the one-third share in the $1 million coastal property to make the $1 million upmarket investment property mortgage-free (approximate rental income at 8 per cent is $80,000), gives a total rental income of $125,000 (after 7.5 per cent management fees).

Adding NZ Super ($13,000) and interest (say 5 per cent) from the $300,000 bank deposit gives an annual income of $152,000 a year continuously, inflation-adjusted. If the writer wanted to live in a $1 million-plus home, he could easily rent that at an expense of probably $500 a week (Auckland prices), which is still only about $26,000 a year.

However, I would suggest that the person use their income to travel.

As you can see, the final figure even after renting a home leaves $126,000 a year, a figure which is a huge $56,000 per annum higher than your first recommendation.

A. Hang on a minute. You seem to be saying our man will receive $80,000 if he rents out a $1 million property but pay rent of only $26,000 if he is a tenant in a $1 million-plus property. That doesn't quite add up.

Nevertheless, your basic point is a good one. The man may well be better off keeping his properties. What I was trying to show was that even if he made conservative investments, he still has enough income to live comfortably.

If he prefers to go for something riskier he will probably be better off still.

P.S. I'm much too nice to point out that your numbers add up to $153,000 a year, not $152,000.