Avalon’s Money Thread – should I pay off my home loan as fast as possible?
I have always thought that paying your mortgage off as quickly as possible is a ‘given’. Not according to these guy’s. That did worry us.
I actually heard a rather good explanation of this from the ASB advisor. I had always thought that getting the mortgage off your back was to be our first priority, and for many people it may still be the best option so I wouldn’t discount it out of hand. That really depends as far as I can see on your personal circumstances, finances, and how good you are with money. I fully believed in this principle when I came here purely from reading the Anita Bell books. I had never really appreciated just how much money you actually pay for a house when you take into account the interest payments over 25years.
Our house cost $595k to buy. But over 20 years taking a 265K mortgage will add 269K to the cost so it will actually have cost us $864k to buy! Interestingly – if you are me anyway – by paying fortnightly for the whole 20 years we save a whopping $53,000 on the cost of our house- that’s a whole lotta coffee!
15142 cups to be precise
However where the advisors are coming from is that if you pay off your mortgage and only do that, you still have no savings with which to live on, so you still have to work to earn an income. Whereas if you were to save / invest at the same time as overpaying a bit on your mortgage you get rid of the debt earlier (and save money on interest charges) but you also have money set aside that you can now live on (or investments that generate an income). That’s the idea anyway!
Hi, everyone, pardon me if I’m asking a silly question but from reading the forum, I have this feeling that most people take up mortgage loan of about $200K to purchase a house, even though they may have the spare cash. Can anyone enlighten me on the reason for such arrangement?
Well, I can’t exactly answer that as for a start if I had $200k in cash hanging around – I would have used it to buy the house instead of taking a mortgage. However – there are 2 theories that could explain at least why some people would do it.
Firstly – revolving credit mortgages are popular here. We have one of these, and part of our mortgage is on this scheme. (About $100k) Now we didn’t actually need the whole 100k, as we have some extra savings, so at the moment only about 60k of that is being used. A revolving credit facility is like a big (huge) overdraft limit. So in our case we have an overdraft limit of 100k, but the balance is only about 60k overdrawn. There are 2 reasons that we have done this:
(1) we don’t pay interest on the portion of the “mortgage” that we don’t use, we only pay it on the 60k,
(2) If we need that money in a hurry we don’t have to ask the bank for a new loan, it’s already “approved” and that money is available at mortgage rates (though please see post on revolving mortgages for why you need to be very careful of doing this).
The other thing that we do that goes against the “get rid of the mortgage fast” is that we are saving to invest alongside paying extra on the mortgage. This money will be used to buy shares to start with and this was a really big thing to get my head round. It’s all very well having no mortgage but do you have any money to live on as well. My parents are a good example of this. They have used $200k to buy a stake in our house. With our money, and our mortgage plus their 200k, we bought 1 big house. They have the money to get rid of at least a huge chunk of our mortgage but they would have nothing to live on (as they have very little income).
Something else I did remember if you are buying now, the exchange rate is very poor (2.5 @ time of writing*), and in some cases it may actually be better to leave some money in the UK, pay an NZ mortgage and then bring the cash over when the rate improves. I can’t remember the numbers, but we worked out that if the exchange rate £-$ went up to 2.85, it would be worth us leaving money in the UK for up to 2 years.
* Oh for the days of an exchance rate of 2.5! Its 2.2 today – and thats up a bit.
Avalon’s Money Thread is a series of posts which were originally written in 2007 for an Immigration Forum. They came about by answering questions that forum members asked, about how to cope with the often difficult financial situation they face in New Zealand. They formed the basis of what was eventually to become the book Avalon’s Guide: after another year or so of drinking way too much coffee and finding out way more about taxes, money and investing that any sane person should.