This article was published on 3 December 2011. Some information may be out of date.

Columnist is wrong — mortgage repayment is well worth it

Contrarian investing — when you put your money into investments that most people are getting out of — sometimes works well. Such investments are usually cheap. But should we extend that to borrowing when most others are repaying debt?

In a recent online article, a columnist advises readers to be “counter-cyclical”. “Money is cheap these days — so why not borrow it and then borrow some more at every chance while low interest rates last,” he says. He suggests investing the money “to upgrade your home or investment property.”

I don’t have a problem with the idea of investing in property. And borrowing to invest usually works well. If the property value grows, you benefit from the growth on not just your deposit, but also the borrowed money.

However, while borrowing to invest makes a good investment better it also makes a bad investment worse — as many people have learnt in recent years. If you are forced to sell when prices are down, the bigger the debt, the further you can fall. Some people end up having lost the property and their deposit, and still owing money.

Mindful of that in these iffy economic times, many New Zealanders have been paying down their mortgages. And that’s where the columnist’s comments are worrying.

“Some stick-in-the-mud advisers (with respect) say differently,” he writes. “They suggest taking the opportunity of low rates to accelerate repayments of principal and interest. After all, they say, when interest rates fall and you keep up the same monthly repayments, it will have the effect of paying off the mortgage more quickly.”

So far, so good. But then he says, “The problem is that principal payments make up such a tiny portion of any loan that it’s hardly worth the effort. Even though it’s true that a component of each payment you make is applied to reducing the mortgage, it takes years to make any sort of dent in the amount still owing through your regular payments.”

That’s wonky thinking.

With a table mortgage — the most common type — regular repayments in the first years are largely interest. That’s because the outstanding balance is big. Many a person has been shocked at how little principal they repay over the first five years of a mortgage — and presumably that’s what the columnist is referring to.

But that’s not what’s going on if interest rates fall and you keep up the old mortgage payment level.

Let’s say you used to pay $1000 a month, but you now have to pay $900. The $900 already includes all the interest you owe. So if you continue to pay $1000, every dollar of the last $100 comes directly off the principal.

That’s what makes extra mortgage repayment so satisfying. It makes a big difference.

For example, monthly payments on a $100,000 25-year mortgage at 5.75 per cent are $629, and you pay about $88,700 in interest over the life of the loan. If you increase your payments by just $50 a month, you will repay the loan in 21 years and four months, slashing total interest to $73,700.

And if you increase the payments by $100 a month, you repay in 18 years and eight months, with total interest of just $63,300. You’ve saved more than $25,000 in interest — real money that you can add to your retirement savings or blow on a huge party.

At the same time, by reducing debt you reduce your vulnerability. If you find yourself in future unable to make mortgage payments, you’ll be in a much stronger position to cope.

Contrary to the columnist’s advice, it’s well worth the effort.

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.