Money matters: A mortgage and shares too: how'd you like them apples?

By MARY HOLM

Q. It is obviously difficult to compare apples with apples when the average Kiwi treats residential property and shares so differently.

If one apple is a mortgage on a residential property there is no comparable apple in relation to shares.

This is because the security offered for a mortgage - a land title - is issued, maintained and guaranteed by the Crown. There is nothing comparable for any other asset class.

So if I walk into my friendly local bank manager's office and ask to borrow some money with a residential property as security, I will be taken seriously.

But if I offer a portfolio of shares in Beauty Direct, e-Force and Strathmore (or even Brierley, Carter Holt and Fletcher Energy) I will be laughed out of the office.

As a result, the ordinary Kiwi joker treats a house with a mortgage as on a par with shares bought with cash, because that is the normal state of affairs.

A. You're right. And because it's so easy and normal to get a mortgage for a house, no one thinks much about it. But perhaps they should.

Someone who came in from another planet would be surprised at how readily people borrow a tenth of a million dollars, or even half a million dollars, to buy a house.

House buyers are often saddled with the debt for decades. And, in repaying it, they might also pay twice as much in interest. They retire with perhaps many thousands of dollars less than if they hadn't had a mortgage - or such a large one.

Why do they do it? First, because they need accommodation and want their own place. Secondly, because in the recent past inflation was so high that the value of the debt diminished fast and the value of the house rose fast. Borrowing to buy a house was wise financially.

The second reason is no longer valid. The first still is. But many people spend a lot more on accommodation than they need to.

They live their lives in relatively high-quality housing, but have much less money available for other things.

Turning from home ownership to investment in rental property, our ordinary joker has much the same attitude, quite happily taking on a large mortgage.

This can be worrying. If you have a mortgage on any investment, you boost your chances of doing well but also your chances of doing badly. Your investment is riskier.

Let's look at an example. We'll use an interest-only mortgage, because it makes it easier to follow - although the same principles apply to any sort of mortgage or loan.

You buy a house for $200,000 with a $180,000 mortgage and $20,000 of your own money.

If you sell the house in a few years for $240,000, you've done well. After paying back the mortgage, your $20,000 deposit has turned into $60,000. But what if you have to sell in a housing slump, and get only $170,000? Not only do you lose the $20,000, but you have to come up with another $10,000.

If, instead, you had invested your original $20,000 without borrowing - perhaps in some other property investment or in a diversified share fund - it probably wouldn't have grown to $60,000 in just a few years.

But there's no way you could end up losing the lot and also owing extra money.

That's why it's probably riskier to invest in a rental property with a large mortgage than to invest in a share fund without a mortgage. It's important our ordinary joker realises that.

What about a share fund with a mortgage?

You're right that banks aren't keen on using shares as security, although some lenders would probably make a small loan on a large share portfolio.

But, once you've built up some equity - house value minus mortgage - in your home, the lender will often let you increase your mortgage. And there's usually nothing to stop you from using that money to invest in shares.

Is that a good idea? Read on.

Q. I often read your column and I am surprised you have never mentioned the following: "If you borrow money to invest in something that will produce a taxable income, then the interest paid on your borrowings is a tax-deductible expense."

This fact, I feel, makes a difference whether people decide to continue to pay off principal on their home loan mortgage or maybe instead convert their loan to interest only and reborrow up to their maximum, investing it instead.

Example: If I was to borrow, say, $100,000 at a floating rate of 8.5 per cent, the real cost of the interest would be only, say, 5.95 per cent (8.5 minus your tax rate).

It is not hard to find a long-term and non-risky investment that will return more than 5.95 per cent after tax.

Am I missing something, or is this a good financial move?

A. We're both missing something.

For you, it's the several times I've written that interest on investment loans is tax deductible. For me, it's a non-risky investment that brings in 5.95 per cent after tax. I don't know of one.

True, if you look in Weekend Money's What they Offer column, on the back page, several institutions are paying more than 8 per cent. But not the banks. And they're the only ones - with the Government - that I would classify as non-risky.

And there's another type of risk that needs to be considered. Term investments paying higher interest rates tend to have terms of two to five years. You might deposit your $100,000 for three years at 9 per cent, only to see mortgage rates rise, over that period, to above that. You'd be going backwards.

The opposite is also true. If mortgage rates fell, you'd be laughing. But you can't be sure that will happen.

Some people would argue that you should drop your "non-risky" requirement and borrow to invest in property, shares or a share fund. The returns will fluctuate, but as long as you stay in for the long term there's a good chance you'll beat mortgage interest rates.

You would have to be prepared, though, to make mortgage payments in periods when your investment isn't doing well.

Another point, and perhaps this is the most important one: Whatever you invest in, you benefit only by the difference between your investment return and the mortgage rate.

If you go into something with an average return of 10 per cent, you're only going to be 1.5 per cent better off for your trouble.

When you weigh the various risks and likely gains, you have to wonder whether its worth the hassle.

Q. My mortgage fixed-term rate is expiring soon. There is $75,000 left to pay the mortgage off. If I continue to pay my normal budgeted amount of $750 a fortnight, I will pay it off in about 54 months. I have been looking at ways of paying it off more quickly by restructuring it.

My bank has suggested that by changing to an account where all my savings, cheque account and mortgage are lumped together I will pay the mortgage off sooner. My savings are small, only $6000 in an emergency fund, and my monthly net salary is about $3500. My spending habits are modest, and usually we live within budget with less than $500 on the credit card. We have no HP agreements.

The personal banker could not give me any figures and was unclear if I would pay off the mortgage earlier. He said that depended on my spending habits.

If I put all my money into this type of account, will I in fact pay the mortgage off sooner?


A. Yes - as long as the mortgage interest rate is no higher than it would otherwise be, and the bank will charge you little or no fee to make the change.

You're not in a situation to be a big winner with this sort of account, sometimes called a revolving credit mortgage.

With such a mortgage, your savings and any other money you've not yet used is credited against your mortgage daily.

That brings the average mortgage balance down, so you pay less interest. If you continue to make the same mortgage payments as before, more of the money can go towards reducing the principal.

Those who gain most from revolving credit mortgages are usually self-employed people who are paid large amounts infrequently and who make payments, such as taxes, infrequently. They often accumulate large sums in their account for short periods.

Still, as long as the two conditions about interest rates and fees apply, you can benefit a fair bit, especially if you set yourself up the right way.

If you put your $6000 savings into the account, it will be "earning" for you whatever the mortgage interest rate is. Say the rate is 10 per cent. You "earn" $600 a year because you avoid paying that much in mortgage interest.

That return will probably be considerably higher than the savings are now earning, after tax.

Beyond that, the idea is to get all your income into the account as fast as possible, and take money out of the account as slowly as possible. Get your salary and any other income paid in directly, if you can. Otherwise, deposit cheques promptly.

Pay your bills close to the due date, preferably by direct debit on the due date. You make your mortgage payments simply by putting in $750 more a fortnight than you take out, so the negative account balance keeps falling.

Put as much as you can on your credit card, and pay that bill in full by direct debit on the due date. That way, you don't pay for items until 30 to 55 days after buying them.

This can lead to credit card bills of, maybe, a couple of thousand dollars, which you might find a bit of a shock at first. But as long as you're only charging items that you would, in the past, have paid cash for, there's nothing to worry about. You're just using the card to delay payment.

I say all this assuming that you're self-disciplined with money. If you're not, I certainly wouldn't recommend a revolving credit mortgage.

Why? You'll be given a maximum loan amount, in your case perhaps $75,000 or $80,000. Your mortgage payments will decrease your balance, but you can always borrow back up to the maximum, with no questions asked.

If you think you won't be able to resist that temptation, stay away. But that doesn't sound like you.

So how much faster will you pay off the mortgage? Your banker's right: no one can predict that. It depends on all your cashflows.

But, if you handle things well, it could easily be several months. And several months at $1500-odd a month is not to be sneezed at.

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