Too much mortgage puts you on thin ice. Photo / Getty Images
OPINION:
Q: I was wondering if you can settle a debate between my husband and I. We are about to sign up to a large mortgage as we have recently purchased a new house. The loan is about $1.1 million and we were lucky enough to save a $300,000 deposit on top.
We own a couple of rental properties on a separate mortgage that is about 50 per cent of the property values.
My husband and I are debating whether we should sell one of the rentals to our tenant, since he showed interest. We will only sell if we can get an offer above $830,000, which will give us a decent profit.
With interest rates forecast to rise this year, my husband is more keen to sell the property so we can reduce our overall mortgage more expediently. Then, in a few years, we can reinvest.
I am leaning towards reinvesting the sale in another investment property so we don't reduce our investment portfolio. Both of us earn a reasonable income and can service our loans. However, we will need to live more frugally, which we have no problem doing.
A: Sorry but I'm on hubby's side. Having two mortgages, one of more than a million dollars, feels scary enough to me. Add a loan for a second rental and you're skating on thin ice.
What could break the ice, tipping you into freezing financial waters? Higher interest rates to start with. Not only are they likely to rise through this year, but they might keep going up to who knows what level — especially if inflation goes mad. That could boost your mortgage payments to huge amounts.
And what if one of you lost your job and couldn't get another at the same pay level? Or you developed health problems? Or perhaps a whānau member needed money desperately? Or one of your properties needed big unforeseen maintenance work? Bad stuff happens.
You might find yourselves being forced to sell a property, which is an investment no-no. You can end up settling for low, sometimes very low, prices.
And that situation could be exacerbated if all house prices fall — which is a possibility these days. How would you feel if your mortgage total started inching towards your property value total? Even if you didn't have to sell a property, you might be in for some sleepless nights.
It's quite possible, of course, that nothing bad will happen and you'll end up better off if you follow your preferred plan. But do you need to take that much risk? It seems to me that you two will be comfortably off even under your husband's plan. Who needs more than that?
One more thing: on selling the property to your tenant, how about not holding out for top dollar? If he's been reliable, perhaps he deserves a good deal. You'll be able to sell without hassle or real estate commission, so you could pass on the benefits of that to him. Kindness is catching.
Q: I am 46 and live in a $1.3 million house with a $150,000 mortgage. I'm scheduled to pay it off in six years. My mother passed away 18 months ago and left me some overseas shares worth $100,000. On average, they are increasing in value by a few thousand dollars per quarter. I also have $50,000 in the bank for emergencies.
My mortgage comes off its fixed period in September. Should I cash in the shares, add my savings, and clear the mortgage then (or even sooner)? Or simply leave everything as is, and be mortgage-free in six years, and still have the shares and savings for retirement?
A: The basic issue here is the same as in the previous Q&A: is it better to invest or pay down a mortgage? But the size of the mortgage, and the fact that you will pay it off in a few years, makes a big difference.
First, I would keep the emergency money where it is. You never know when you might need it. But what about using the shares to speed up your mortgage-free day? You need to weigh up:
• The returns you will make on your shares from now on.
• The interest you will pay on your mortgage from now on.
That's because getting rid of a mortgage at x per cent helps your wealth in the same way as an investment that earns x per cent.
In the recent past, you've probably been earning more on your shares than your mortgage interest rate. But loan rates are rising, and future share returns are always unknown. On average, share returns will win, but not always — and they can be negative.
It all depends on your appetite for risk. What feels best for you?
One further point: if you pay down your loan before September, you may be charged a penalty — although that's less likely when interest rates are rising. Ask the lender. If there's a penalty, wait.
Q: I'm 46, and worked all my life but never in highly paid roles — I've worked for not-for-profits and the government.
I finally have just enough for a 20 per cent deposit on a $500,000 home. Apart from trying to find a home for this price (I live in Auckland but know I have to leave), doing the maths I'll be lucky to have paid a third off by the age of 75.
What do I do? Do I even go ahead? I have no investments or assets and am very unsure of whether I go ahead.
A: Well done on your savings on relatively low pay.
I'm wondering if your maths is accurate. Did you take into account that you would no longer be paying rent? And that you would no longer be saving a deposit?
I suggest you discuss your situation with a mortgage adviser. They are free to you, and you are under no obligation. They can help you work out whether you will qualify for a mortgage, and what the payments would be.
If a bank is willing to lend to you — especially these days with stricter lending rules — that suggests you can make it work financially.
If you can't get a mortgage, you've got good savings to take into retirement. And if you keep saving, you might find you qualify some time in the future.
Most people much prefer to head into retirement with their own home. Even if you're still making mortgage payments, you're not subject to rent increases or landlords moving you on because they want to sell.
Good luck. Let us know how it goes.
Q: On 1 September 2021, my KiwiSaver (ASB Balanced fund) balance was $308,205. On 20 January 2022 my balance was $301,617. So, a paper loss of $6588.
While I'm not deliriously happy with this, I understand the risks and rewards of this investment type, so I'll suck it up along with everyone else.
During the same period of declining returns, ASB charged me $773 in management fees — about $154 a month.
Is there a place in the KiwiSaver market for a provider to implement a shared risk, shared reward model? A model that reduces fees during lean times and ups them during the good times?
A: Some KiwiSaver providers already do that — sort of. They charge a regular fee and, when things go well, a performance fee. But they don't reduce their fee in down markets, although I suppose they could argue that their regular fee is lower than it would otherwise be because they sometimes get the bonus.
Anyway, performance fees come with problems. As I said in this column last June, these issues include:
• They can incentivise managers to concentrate on short-term performance, when the long term is what matters for investors.
• Managers might be tempted to take inappropriately high risk in the hope they will be in luck and will earn extra fees. If their "bet" goes the wrong way, they still get the ordinary fees. They are not penalised.
• The fees must be structured so managers are not rewarded if nearly all KiwiSaver funds at the same risk level do well in a period, but only if they rise above the pack.
The Financial Markets Authority is keeping an eye on KiwiSaver performance fees. It says the fund managers must set a "hurdle rate of return", based on the risk level of their fund. They have to earn more than that rate to get the performance fee.
The managers also have to set a "high water mark" — at their highest performance level. If the fund's value drops from there, they can't claim a performance fee until it rises above the high water mark. This prevents providers being rewarded for simply recovering from a big fall.
Your reader's "rules" last week included "Relying on capital gain for an investment property while being negative cash flow is risky — especially if you don't have insurance".
I wonder how many people believe they can generally buy rental property without any "negative cash flow"?
This depends on deposit amount, interest rate, luck regarding maintenance, vacant periods, whether tenants actually pay, and even changes in government policy, especially on tax deductibles.
My wife and I have been owner-occupiers, landlords and renters in the UK, Hong Kong and New Zealand over many years. Based on our experience, assuming a mortgage of around 80 per cent, if interest rates are low, and rental returns are high compared to purchase prices, it may be possible to avoid negative cash flow.
But with a 25-year mortgage, with interest of 5 per cent and rental income of 5 per cent, on a $1 million property with an $800,000 mortgage, the payments exceed the rental income by about $10,000 a year, before other outgoings, including insurance. Of course interest can easily go much higher than 5 per cent, and return can often be down to 2 to 3 per cent.
Starting in the rental game, I naively believed that rental increases would follow price increases. Experience taught me they can frequently be unconnected.
I'd say you should not get into rentals unless you can either put down at least a 30 per cent deposit, or can tolerate some negative cash flow, possibly for the whole time you have a mortgage, and are in it for the long term.
When values take a big drop they often take five to 10 years to recover. Of course it may still be worthwhile, because even if there's no capital gain (which over 15 to 20 years is unlikely), in the end you will have a mortgage-free property which has largely been paid off by someone else.
A: Thanks for some useful guidance.
I still think the "rule" is valid, though. As I said in today's first Q&A, people are sometimes forced to sell properties at low prices when they can no longer meet mortgage payments. I know a man who found his sale proceeds didn't cover his mortgage. He was left with a debt to the bank, and nothing to show for it.
This may happen more than we realise. People don't skite about such predicaments.
Also, your last sentence perhaps puts rental property in too rosy a light. Landlords need to take into account the money they put into a deposit years ago, which could have been compounding in, say, a share fund. Then there's all the expenses and mortgage payment top-ups over the years, which could also have been compounding.
Having said that, many landlords do really well out of their investments.
- Mary Holm, ONZM, is a freelance journalist, a seminar presenter and a bestselling author on personal finance. She is a director of Financial Services Complaints Ltd (FSCL) and a former director of the Financial Markets Authority. Her opinions 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. Send questions to mary@maryholm.com. Letters should not exceed 200 words. We won't publish your name. Please provide a (preferably daytime) phone number. Unfortunately, Mary cannot answer all questions, correspond directly with readers, or give financial advice.
OPINION: Turns out the human brain is not well evolved to handle money.