NZ Herald 13 October 2018

AThis is not a new issue for this column. But it affects so many people that it’s worth looking at again.

The short answer to your question is that it’s probably better to put extra money into paying down your mortgage.

If you were earning less than $35,000 a year — actually $34,762 — it would be good to raise your contributions to KiwiSaver. That’s because at 3 per cent you would be contributing less than $1043 a year, so you wouldn’t receive the maximum tax credit of $521.

But on your salary that’s clearly not an issue. And of course you’re also getting your employer’s 3 per cent contribution. So you’re already receiving the full KiwiSaver bonuses.

That means that any extra you put into KiwiSaver will grow by whatever the return on your fund is.

If instead you put, say, $1000 into reducing your mortgage, you would avoid paying mortgage interest on that $1000. And here’s a key point: avoiding paying 5 per cent interest improves your wealth in the same way as earning 5 per cent on an investment.

So you need to compare:

• Your mortgage interest rate, which we’ll say is 5 per cent.
• The likely future return in your KiwiSaver account — after fees and taxes.

If you’re in a lower-risk KiwiSaver fund, the mortgage rate is probably higher.

In a middle- to higher-risk KiwiSaver fund, though, your after-tax and after-fee returns in recent years could well have been more than 5 per cent. The big question is will that continue? Nobody knows, but returns aren’t usually that high for that long. In higher-risk funds they are quite often negative.

In other words, putting extra money into KiwiSaver, as opposed to paying down your mortgage, is riskier.

There’s the psychological issue too. Most of us want to reach retirement with a mortgage-free home. It would be good to set that as your aim. If you get rid of the mortgage before retirement, by all means boost your KiwiSaver savings at that point.

Two points to consider about paying down the mortgage:

• If your mortgage is fixed, there may be penalties if you pay it off faster. But many lenders let you increase your payments to some extent without penalty. Ask your lender. If necessary, save the extra money in bank term deposits until the fixed term ends. And then reset the mortgage with at least some of it at a floating rate. You can then pay it down freely.
• Don’t muck around — as most of us have a tendency to do. Set up extra mortgage payments now, perhaps as an automatic transfer the day after payday. Murder that mortgage!

AI agree with much of what you say — although the fees shouldn’t be higher because you’ve split your money over more than one fund.

But you’re ignoring the educational side. As I said last week, “Putting some of your money in a higher-risk fund is a good way to test whether you can cope with markets ups and downs.”

You can watch your balance in that fund move, and sometimes fall, before deciding whether to move all your money into it.

AWe’ll start with a couple of definitions for other readers:

• With a reverse mortgage, you borrow money in retirement and make no repayments, so the loan grows over the years. It is usually repaid when the last borrower permanently leaves the property — maybe when you go into a rest home or die.
• A revolving credit mortgage is like an ordinary home loan, but it’s part of your everyday bank account. If you’re using it to buy a home, it will have a large negative balance at first. It’s like a large overdraft facility at a housing interest rate.

It’s best to put all your income into the loan account and pay bills from there, so that any money that is sitting around — even for just a few days — is credited against the loan. Interest is calculated on the daily balance which, because of the sitting-around money, will be lower than if your mortgage was in a separate account.

You’re expected to pay down the loan over time, but you can borrow again if you need to — up to a maximum limit. For this reason, revolving credit mortgages don’t suit people who aren’t disciplined about spending. But for others, they can work well.

For your plan to work, firstly check that you have the right type of revolving credit mortgage. With some, the limit decreases over time. Obviously it would work better if the limit stays unchanged.

Then there’s the question of whether the lender would let you keep using the loan into retirement.

A mortgage adviser says a bank might withdraw the facility at some point after you retire. “Having said that, we have known of retired borrowers who have (themselves) negotiated a revolving credit facility (RCF) — or a loan and a RCF, with the RCF servicing the interest on the loan — with their bank, although our understanding is that banks are generally reluctant to offer such facilities.

“I don’t think that borrowers would necessarily want to rely on the facility being available to them forever,” he says.

The big problem is that if you borrow and make no repayments, the loan will grow at an increasing pace because of compounding interest. If it runs for several decades, you would end up owing way more than the amount you have borrowed.

“There is a risk that they reach the maximum limit available and cannot service the debt from cashflow — which is why, I believe, banks are generally reluctant to offer such facilities to borrowers that are unable to prove that they will be able to service the debt on an ongoing basis,” says the mortgage adviser.

“The bank could demand repayment of its debt, and if the borrower is not in a position to refinance to a reverse mortgage (for whatever reason), they might find themselves with very few options.”

His conclusion about your idea: “In theory, it is a simple and sound suggestion. However, in practice, it might not work as well as may be hoped. I think that some reverse mortgage options could provide more comfort to a borrower in the medium to longer term, despite the higher costs involved.”

The comfort might include the fact that reverse mortgages usually come with the right to occupy the house for the rest of your life, and a “‘no negative equity” guarantee, which means you won’t ever owe more than house is worth.

These safeguards could really matter if, for instance, interest rates rise a lot.

If I were you, I would discuss your plans with the lender before you start running up the revolving credit mortgage balance. You don’t want to discover later that you’ve created a problem for yourself.