This article was published on 2 February 2013. Some information may be out of date.

Q&As

  • Interest-only mortgages have major flaws
  • Another — good — approach to reverse mortgages
  • Are the banks ripping us off with reverse mortgages?
  • Spending certainly didn’t decrease for this new retiree
  • KiwiSaver contributions flexible

QRegarding reverse mortgages — I wonder in some cases if an interest-only home loan is a better option for borrowers who are worried about the amount of the loan going up.

In many cases, an interest-only loan will have affordable monthly interest payments, and the borrowers will have the knowledge that their debt won’t actually increase — effectively they are just treading water.

I know it may not suit everyone, and some people could not even afford the interest — but for others it may be an option.

AYour idea sounds good at first. But interest-only loans are a bit like candy floss. They look enticing, but they’re disappointing.

With reverse mortgages — which are usually taken out by retirees who make no payments until their house is sold — they are probably particularly unsuitable.

This is because the only people who should consider reverse mortgages, in my opinion, are those who have used up any retirement savings and are living on just NZ Super. It would be silly to have savings on the one hand and a debt on the other hand that is probably growing faster than the savings.

And if you’re in that situation, it’s unlikely that you’ll be able to pay interest.

Having said that, you may find that after you’ve taken out the reverse mortgage, your expenses reduce as you get older and go out less. If you have spare NZ Super money, you might want to put that into the mortgage to keep down the loan balance.

It would be good to ensure, at the time you took out a reverse mortgage, that you could do this without penalty.

More generally, younger people often use interest-only mortgages for short periods. You might, for example, get such a loan to tide you over if you’re paying two mortgages because you’ve bought a new house and not yet sold the old one.

Obviously, payments are lower on an interest-only mortgage. But don’t be enticed into staying with one for long.

Why? We’ll start by looking at table mortgages — by far the most common principal and interest mortgages.

Most of the early payments on these loans are interest, with just a little principal repayment. Some examples of mortgage payments in the first month of a $300,000 loan:

  • On a 20-year loan at 6 per cent you pay $2149, of which $1500 is interest.
  • On a 30-year loan at 6 per cent you pay $1799, of which $1500 is interest.
  • On a 20-year loan at 9 per cent you pay $2699, of which $2250 is interest.
  • On a 30-year loan at 9 per cent you pay $2414, of which $2250 is interest.

The longer the term and the higher the interest rate, the bigger the proportion of your monthly payment is interest. But in all cases, interest makes up the bulk of the payments.

However, because you’re gradually repaying principal, the interest proportion diminishes over the years, until the last payment is almost all principal. But of course that doesn’t happen with an interest-only mortgage.

Let’s say, then, that you’re considering a $300,000 mortgage at 6 per cent, and your options are:

  • An interest-only mortgage, on which you pay $1500 a month — forever.
  • A 30-year table mortgage, on which you pay $1799 a month. For just $299 more, you gradually pay the loan down to nothing.

It’s not hard to see which is better.

Footnote: Some people get an interest-only mortgage on a rental property, counting on selling the property later at a gain. Rental property is already riskier than many realise. And making no inroads into the principal ups the ante.

QHere’s another approach to reverse mortgages. When my mother was faced with a shortfall between the sale price of her home and the property she wanted to move into, she, my two sisters and I raised a $20,000 mortgage for the difference.

We three daughters were each registered on the property title at a fixed percentage, which increased slightly every year. This ensured that our contribution to the property was recognised by another sibling.

Each of us paid around $80 a month towards the interest and principal. No one had to find $20,000 on the spot, and the investment turned out fine when my mother’s estate was settled.

AThis builds on the previous correspondent’s idea, that you can do lots with just a little money per month. But I like this variation on the theme better.

In circumstances like yours, with another sibling who didn’t participate, it would be important to spell out at the start how the arrangement would affect everyone’s inheritance.

Thanks for a good idea.

QI read with interest your comments last week regarding reverse mortgages, in particular lending risk.

I have no axe to grind here, apart from my view of banks’ behaviour. But I suggest the banks have no risk at all, they will never dip out when the property is finally sold.

They will always get the loan value and a good portion of the interest even if the borrower lives on for some time. For a start they don’t lend 100 per cent of the home value.

The 7.25 per cent compounding is excessive. It should be no more than a standard loan. The compounding interest should be capped at no more than the loan value itself. They get double the investment, not bad without risk.

As one can see a $41,290 loan quickly turned into $61,835 — about half the original loan. Tell me what other real businesses get those value increases. They don’t.

The world will never get out of its current situation when banks control all that we do and are allowed these practices. Lucky I won’t need predatory bank loans as I get old.

I really feel for elderly that have paid tax, went to war to save this country and the banks, and this is how they are treated at the end of their lives. They are forced to worry because of bank practice when their days are numbered.

All of us just accept predatory practice by banks, which invariably comes from some faceless peanut inside the bank. Then you endorse a so-called risk the banks have, and you even believe it.

ALet’s say you — as a young man — inherited $10,000 money and invested it. Would you be happy to limit its growth, over 30 or 40 years, to $20,000? You’d be mad if you did. But that’s what you’re asking banks to do.

For a bank or anyone else to double their money over a few years is great. But over decades it’s lousy.

I’m not here to apologise for banks. Their profits seem excessive, and I would like to see them treat customers in trouble more kindly.

But let’s look at the banks’ basic role. They take in deposits and pay interest for the use of that money. They then lend the money to borrowers and charge them interest — which they use partly to pay the depositors.

Sure, they charge more interest than they pay out. That’s how they cover their costs and make a profit. And there’s a good argument that the gap between interest coming in and going out should be smaller. But that’s a different issue.

If we said banks couldn’t charge any interest on long-term loans once they had doubled, no bank would make long-term loans.

A couple of other points:

  • If the 7.25 per cent ASB charges on reverse mortgages is such a good deal for the bank, why aren’t other banks also doing it? To my knowledge, ASB is the only reverse mortgage game in town at the moment.
  • I, too, feel for the elderly couple in last week’s column, but the lender didn’t make them take out a reverse mortgage. If anyone’s to blame, it’s those who advised them to do it without fully explaining it.

QYou really must try and break the myth common amongst financial advisers that as people age they spend less.

Try adding the cost of glasses ($500+); hearing aids ($2000 per ear); cataract operation ($5000 per eye) to your everyday running costs.

Ten years ago I could cut and split my own firewood. Now I need a log splitter ($500+) and, because I don’t work, spend more time at home and feel the cold more I need even more firewood. I don’t feel confident enough to climb on the roof any more so I have to employ someone to replace the bird netting round the chimney or to do similar high maintenance work. House painting is getting more difficult, and I hate to think what the hourly rate for that sort of work is. The list increases as the years go by.

So what are you going to do with all the extra time you have now you are retired? Sit and read or watch TV or travel a bit more ($) and pursue your hobbies more vigorously ($) or even start some new interests ($)?

Bust the myth!

AFair point. You must have saved on employment-related expenses such as travel to work and clothing, but it seems in your case that those savings are way more than offset.

However, as people get into their eighties, a lot say they spend less because they travel and go out less — as noted in today’s first Q&A. Something to look forward to?

QI understood one had to contribute at least $20 a week to be in KiwiSaver. Last week you mentioned entering and just growing the $1000 on its own. Surely one has to keep paying in?

I am trying to convince my disabled daughter to join.

AKiwiSaver contributions are pretty flexible.

If you are an employee, you have to contribute at least 2 per cent of your pay, rising to 3 per cent from April 1, for the first year. But any time after that you can take a contributions holiday and stop contributing.

If you are not an employee — and that includes the self-employed, beneficiaries, people taking care of others, early retirees or anyone else — you can sign on, get the $1000 kick-start and leave it at that. Or you can contribute any amount you like.

It’s good to put in $20 a week or $87 a month, as you will then receive the maximum tax credit of $521 a year.

Note that the tax credit is misnamed. It’s nothing to do with tax, but a gift into your KiwiSaver account. So you don’t need to be a taxpayer to get it.

Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and 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 [email protected] or click here. 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.