Should you make extra mortgage payments?

5 reasons why you shouldn’t pay off your mortgage any sooner (yes, you read that correctly)

Most of us are aware of the benefits of repaying a mortgage sooner by making extra payments. These benefits include saving on interest repayments, being mortgage-free faster and obtaining a sense of security that comes with a debt-free roof over our heads.

However, on the flipside, there could be a few benefits to not making extra mortgage payments. At first this might sound like crazy talk, (though most of us might agree the world has gone a little crazy lately!) though try keeping an open mind and read on to learn more.

1. Paying off higher interest debts such as credit cards

Many Kiwis are still having a hard time with credit card debt, vehicle loan repayments, and other consumer debts such as store cards and the modern buy now pay later schemes such as Afterpay or Laybuy.

If this is the case, the interest rates can be ten times higher than the standard mortgage interest rates so it makes sense to tackle these ‘bad’ debts first.

2. Building up a rainy-day fund

It’s smart to save enough accessible cash for the emergencies and expenses we all occasionally face. Yes 2020 and, some of 2021, has reinforced the importance of this.

Many gurus suggest a cash horde of 3-6 months’ worth of living expenses just in case there’s a job-loss or something unforeseen, though (as with anything in life) what any individual or family needs depends on them.

Without such financial reserves in place, anyone with a mortgage could put themselves at risk of not being able to make their repayments should something unexpected occur.

3. Build up cash for something ‘good’

This can be broadly broken down into two categories:

i. A deserved reward

If you are fortunate enough to be in a position to, perhaps it’s time to start saving for an overdue holiday to Australia or the Cook Islands? Or perhaps to save and spend on a major item, significant life event, or major experience you’ve thought of but not got around too?

It doesn’t make much sense to go into credit card debt or fund such a trip with additional mortgage lending. Saving up for it will probably make the reward that much better too!

ii. To make a big move

Aside from an emergency ‘rainy-day’ fund of some kind, there could be other reasons to build up cash:

• To fund a training course or qualification so you can earn more, or
• Some investments have minimum thresholds or might not make much sense with a small sum. This might include subdividing a property or another significant activity, or
• To buy in to a business or other venture, perhaps with a close friend or family member, or
• To start a business or side-hustle of your own.

Beware

Despite what is mentioned above, against the backdrop of low interest rates saving money as a long-term wealth building strategy is unlikely to work. Unless there is a specific short-term need, nowadays it is usually unwise to save money over the long-haul in bank accounts and term deposits.

‍Learn more: don’t save money.

4. Invest into investment markets instead

One of the biggest arguments against repaying a mortgage any faster than needed is the likely difference between long-term interest rates and long-term investment returns.

Consider the last 10-year performance of:

• The NZX 50 Index, which is the most common measure of the NZ sharemarket, which has averaged over 9% per year without even including dividends.
• The S&P 500 Index, the most common measure of the US sharemarkets, has averaged nearly 12% per year in USD, again without including dividends.

Most commentators do not expect the strong results above to last forever, but even half of those average annual rates is still significantly higher than what most expect of mortgage rates for the foreseeable future.

The difference between the mortgage interest rate and the investment return is where the long-term opportunity might be.

Diversification and flexibility

Aside from just a pure “interest rate versus investment return” calculation, there are probably other benefits to this too.

For example, there are an array of highly diversified non-KiwiSaver investments available, commonly called managed funds. With low fees, the ability to access your money at any time, and no contribution or withdrawal costs, these sorts of funds might be a good choice instead of extra mortgage payments, as the benefits on offer could include:

• Start to diversify wealth away from just a home and KiwiSaver, and
• Offer greater flexibility than just paying down a mortgage. The invested funds can usually be accessed at any time without charge or penalty. This compares a lot better than running to the bank ‘cap in hand’ to try and get extra lending to spend on something such as a year off-work travelling (once Covid subsides), to fund a renovation, children’s education, or for any other reason.

5. Refinance or restructure the mortgage

Instead of making extra mortgage payments, there are several choices here which could work well if used in conjunction with the other points on this list:

• Refinance. Refinancing is the process of switching a mortgage from one bank to another and renegotiating the terms of the loan. In most cases, the idea is to get a better overall deal, as banks will often entice new business off competitors and offer great rates and even cash incentives.
• Refix. When any fixed rate mortgage is coming to the end of the fixed rate term, the bank will offer a new rate. The end of the fixed term is your opportunity to review your needs, as well as personal and financial circumstances. As NZ mortgage rates have steadily tracked downwards for the last 10 or so years, chances are the situation can be taken advantage of by refixing your mortgage at a lower rate.
• Restructure. While the mortgage interest rate is important, it’s not the only thing to consider. Mortgage restructuring is the process of rearranging a home loan into a winning combination of fixed and perhaps floating interest rates, setting the right term or terms for fixed portions of the loan, and ensuring appropriate loan repayment amounts are set. You could use your surplus income to invest into higher earning investments or to spend on something really important to you.

In many cases, chronically low interest rates and stiff competition between the big banks means that many people can drop their mortgage repayment to increase their regular surplus while still paying off the mortgage in the same timeframe (so the increased regular surplus could be used for a good reason elsewhere), or keep their mortgage repayment the same and still repay it years earlier, or another arrangement to suit them and their situation.

Talk with our lending team to see if this might make sense for your situation: get in touch.

The bottom line – should you make extra mortgage payments?

The interest rates for mortgages and bank savings accounts are at historical lows and are expected to stay somewhere near current levels for some time yet.

This means mortgage interest rates are expected to be at least a couple of percent lower than what a diversified investment portfolio is likely to earn in an average year, and that difference is where the wealth-building opportunity may lie for many people who are currently repaying a mortgage or considering making extra mortgage payments.

Of course, things are not always a clear-cut equation, so it would be the pleasure of our team to have a chat about which option or combination of them might best suit your particular situation. This includes if you’d like to explore investing, refinancing or restructuring your mortgage.