Paying down your mortgage when rates rise is a sensible idea. Photo / NZME
Paying down your mortgage when rates rise is a sensible idea. Photo / NZME
When mortgage rates go up, doubling down to pay the debt off faster makes a lot of sense. Smash your mortgage like an avocado.
With floating mortgage interest rates topping 7 per cent and predicted to go higher, reducing the outstanding capital lowers the fortnightly or monthly repayments.
Don’t fallinto the trap of thinking you can’t afford it. Most homeowners can afford the rises on paper at least. Thanks to the much maligned Credit Contracts and Consumer Finance Act (CCCFA), banks are quite rigorous in their assessment of what homeowners can afford to pay. Even when interest was super low, buyers were tested at rates around 7 per cent.
Historically, the new rates are not that high. Floating interest rates were above 7 per cent from 2004 to 2008 and hit over 10 per cent for more than a year in 2007/2008.
The trouble is human brains are hardwired with biases that make it hard to swallow the idea that interest rates rise. Professor of Experimental Economics at the University of Auckland Ananish Chaudhuri says this behavioural economics concept of Present Bias shows itself when someone who takes a loan out at 3 per cent does not allow for the fact that it might rise significantly, even if they’ve been warned. Present Bias was seen in the subprime mortgage crisis in the United States during the global financial crisis (GFC), says Chaudhuri. Borrowers were given low introductory mortgage rates but lost their houses en-masse when those rates rose to the levels they’d been forewarned of.
Don’t let this bias get the better of you. Rather than “I can’t”, try: “how can I make this work?”. An extra $200 a week paid down on the mortgage adds up to $10,400 a year. At 6 per cent each $10,000 paid down on the mortgage adds up to $60 a month saved, says mortgage adviser (broker) Lisa Meredith of Loan Market.
Smashing the mortgage requires a dollop of budgeting and an honest look at needs and wants. Can you game yourself to pare back unnecessary spending? Paying down debt fast can be very satisfying.
Borrowers are means-tested at higher interest rates to make sure they are able to pay off the loan if rates go up. Photo / 123RF
Earning more is also very useful when paying extra on the mortgage. That can mean focusing on getting a pay rise, or a side income. If a little person has joined the family and one member of the couple has stopped working, can that partner get a part-time job out of hours when the other is at home? It’s hard, but plenty of people do just this to make ends meet or get ahead.
However you find the extra money, take some advice on how to make the most of it. Meredith has recommended to clients still on low fixed rates to start paying at the higher rate before they’re forced to. This gets them used to the extra repayments at the same time as reducing the mortgage by the overpayments.
Make sure the loan is structured to make the most of your hard work, says Meredith. On most fixed-rate mortgages banks will let you repay an extra 5 per cent per year without penalising you, she says. If you want to repay more, you could hold the money in a savings account until you can restructure the mortgage.
One of the easiest ways to structure a mortgage for overpayments is to leave a portion of the capital on a floating (variable) rate, which does not penalise extra payments. Should there be even the slightest chance you might need to redraw some of those overpayments at a later date, then consider getting a mortgage with a redraw facility, Meredith says. A revolving credit mortgage can be the answer as well.
Not thinking this through beforehand can lead to difficulty. Meredith was approached by one couple who had paid off more than a third of their mortgage in two years. When one member of the couple couldn’t work, the bank decided that they had to keep paying at the same rate they’d been doing voluntarily, which they could no longer afford. It made no sense because they could still afford to make standard repayments on the original term. But the bank wouldn’t budge. Meredith managed to remortgage them with another bank that could see sense.
