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Should I Split My Mortgage?

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Contributor:
Mary Holm
Mary Holm

Question:

I'm interested in ways to painlessly reduce mortgages.

I'm aware of ways of structuring a home loan so that you can pay it off faster. In a scenario often postulated and oversold by mortgage brokers, you could in theory pay off your loan in 10 years instead of 25 years.

Such restructuring involves splitting the total loan amount into two portions: portion one, say 20 per cent of the total amount in a floating rate loan, and the remainder on a fixed rate. But it can be any combination.

The theory behind the split loan structure certainly stacks up on paper but is extremely difficult to put into practice and achieve the intended result.

In my 15 years of working in a leading bank here, I have found that having a portion of your loan on a floating rate, and having the ability to redraw this portion of the loan, is almost like committing financial suicide. The temptation to draw on this facility for emergency or other purposes is simply too difficult to resist for the vast majority. Instead of shortening the loan term, it often ends up achieving the opposite.

One sure-fire way to pay off your mortgage earlier and which is seldom discussed anywhere is stepping up your loan repayments at regular intervals. There is a provision in most banks' loan agreements to allow the borrowers to step up their loan repayment by a maximum of 10 per cent of the original repayment amount. Instead of paying $2000 a month, you are at liberty to step it up to $2200, without attracting any
penalty.

During the years when I had a mortgage, I stepped up my fortnightly loan repayment by a paltry $30 a quarter, and then a further $30 the following quarter, virtually every year. A sum of $30 may not sound much (and is something most people can afford if they have a couple of drinks fewer on Friday!), but the effect is compounding.

At the end of the first year, I was paying $120 more a fortnight. In the past several years, I am sure most people would have got pay rises much higher than $120!

If you repeat this process, you will pay off your mortgage in next to no time. I certainly did, without any sacrifices in luxuries like an overseas holiday for the entire family every three to five years.

At a time when interest rates are literally tumbling, I also suggest borrowers keep their old loan repayments, instead of using the saving for other things.

If only people knew how to calculate these things and realised how much more they could reduce the principal amount at a time of low interest rates, I am sure it would send the banks broke.

There are in fact no excuses for not knowing how to calculate your loan payments. The Sorted website is an excellent place to start. The website is inundated with tools for loan calculations. I only wish people knew.

Answer:

More than a few do - but your letter may put others in the know. The Retirement Commission, which runs www.sorted.org.nz, said just the other day, "January's always busy on sorted.org.nz as people plan for the year ahead, but this January has set new records, with 163,000 visitors to the website - nearly a third more than January 2008."

And one of the most popular tools on Sorted is the Mortgage Repayment calculator, "which can help people review their mortgages in the light of changing interest rates. There were 1.3 million calculations on this tool in 2008, and 216,000 in January 2009," says the commission.

Meanwhile, thanks for several good tips - worth a bit more than two cents, in my opinion. Your warning about loans on which you can redraw is important. For some self-disciplined people it can work well, for others, as you say, it can be a disaster.

Your stepping-up idea is excellent. It's amazing what such strategies can achieve. And, as you say, just maintaining the old payment level when your mortgage interest rate is reduced can be pretty powerful.

For example, on a $100,000 25-year mortgage with a floating rate of 9 per cent, monthly payments are $839. If the rate drops to 8 per cent, your monthly payments would fall to $772.

It would be tempting just to enjoy the lower payments. But if you keep your payments at the old $839, you will cut the term of the mortgage from 25 years to less than 20 years. What's more, you will pay about $23,000 less interest over the life of the loan.

What if the rate drops to 7 per cent? Your monthly payments would fall to $707. Again, if you can resist temptation and keep up the old $839 payments, you will pay off the mortgage in just over 17 years. That's a big difference. And you'll pay more than $30,000 less in interest.

If you have a $200,000 mortgage, rather than $100,000, double the dollar figures above. If it's a $500,000 mortgage, multiply them all by five. Your interest savings from maintaining your old payments will be huge.

Finally, thanks so much for your opening comments. I usually edit them out, but I've had several letters lately complaining about my publishing too many Q&As about KiwiSaver. Given that pretty much every New Zealand under 65 would benefit by being in the scheme, I don't think I overplay it. But it's lovely to have your encouragement.

 

Mary Holm is the author of bestselling books on KiwiSaver and personal finance. She is also a highly praised seminar presenter. Her written advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following that advice.        

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