Falling interest rates are great news for homeowners – but pocketing your mortgage savings could be the worst financial decision you make, says the Commission for Financial Capability’s David Boyle.
A couple of things happened in 1988 that stick in my mind: I got my hands on The Pogues’ album If I Should Fall From Grace With God, which took such a thrashing on my stereo the neighbours thought they were living next door to an Irish pub. And I bought my first house.
Elsewhere in the world someone grew a seedless watermelon, Sega launched its mega drive console and Prozac was launched. The arrival of the anti-depressant proved timely given what was to follow in New Zealand.
But first, back to my house. I could barely afford to furnish the place; all I had was a bed, that stereo I mentioned, and a couch and TV I’d borrowed from my grandma. I didn’t even have a fridge. Yet I was rapt, despite the interest rate making my eyes water. Did I mention it was 18% back then?
You couldn’t wipe the smile off my face for the first three months, and then the unthinkable happened: interest rates hit 20%. I’m sure I wasn’t the only person who greeted this news with an urge to be sick – or reach for the Prozac.
Instead I relied on rent from some flatmates, but that didn’t stop me freaking out about losing my home if the rate continued to climb.
So I took a long hard look at my spending and came up with a plan to pay off my mortgage as fast as was humanly possible.
It’s a different story now: money has seldom been cheaper, with interest rates lower than they’ve been for 60 years and a feeling of wealth among homeowners, especially in Auckland.
But I’d say the same to anyone with a mortgage today: get rid of it as soon as you can. Look at whether you can increase your payments: even a small amount can make a big difference over the long-term.
Because, while today’s 5.6% variable rate sounds a hell of a lot more manageable than 20%, I had borrowed less than double my annual income. In Auckland the median house price is nearly ten times the median income. For the rest of New Zealand it is still a hefty six times.
That could leave an alarmingly small buffer to cope when interest rates start to climb again.
And they will. One thing is certain: anything that goes down will eventually go back up; it always has, it always will, and it could be sooner than people expect.
Writer Doug Larson quipped: “People are living longer than ever before, a phenomenon undoubtedly made necessary by the 30-year mortgage.”
But it doesn’t have to be like that. Now is the time to work out a plan, just like I did nearly 30 years ago, to see how much more you can add to your loan repayments. (Use the Sorted mortgage tool to calculate this.)
If you’ve borrowed $600,000, which isn’t unusual in Auckland, are paying it off over 30 years at 5.6%, it’ll cost you $1,589 a fortnight and you’ll end up paying a total of $1.24 million.
Last year, when interest rates were at 6.75%, you’d have been paying $1,795 a fortnight – that’s an extra $206.
If you had carried on paying the same $1,795 when the rate fell to 5.6%, you would be rid of that mortgage seven years earlier and would save yourself $338,000 in interest.
While homeowners are working out how to demolish that mortgage, there’s another group praying for those interest rates to climb.
You’re the ones who are no longer working and rely on savings and investments for an income, with most of your money in bank term deposits.
Things are probably feeling a bit grim right now and there may be a temptation to chase higher returns. At times like this your eye might be caught by flashy ads promoting higher interest rates, however they can come with a lot more risk.
To you too, I offer the ‘p’- word. Make a plan. If you’re lucky you can wing it for a while without one, but there comes a point for all of us when we’ll do far better if we write down what we want and how we’re going to get there.
It doesn’t have to be on a scale with War and Peace – bullet points on a postcard can be a great start.
Even better: talk to someone who knows about these things so they can go through your options. Discuss how much money you have, whether that’s savings, investments or your home, and think about whether now is the time to start spending some of that money you’ve saved.
After all, you worked hard all your life to build it up for the time when you really need it.
By the way, I still give The Pogues a good blasting occasionally, showing some things never change – though I’ve upgraded the stereo and, yes, I paid in cash.
David Boyle is Group Manager, Education and Retirement Villages at the Commission for Financial Capability
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