Weekend Money: Beating mortgage interest

Q: We are retired (aged 57), and our joint income is solely from investments. These comprise about $530,000, spread between bank term deposits, managed funds, NZ shares, nominee mortgage, St. Lukes capital notes, ANZ Bank shares (Australia) and cash.

We have no debt, and pay tax at 19.5 per cent.

We own our unencumbered home, value $450,000, and are considering upgrading to a new home, maximum cost $550,000.

If we expend $100,000 on a replacement home, what do you suggest would be the preferred option?:

Meet this from sale of investments or

Borrow $100,000, spread between 50:50 fixed/floating mortgage, interest only or

Borrow $50,000 interest only, meeting the balance from investments.

In the coming years, we do not anticipate receiving any Government Super, and will rely on our current resources.

A. Lucky you - or perhaps I should say hard-working and clever you - to be out of the work force so young.

While you seem to be sitting pretty, though, you might want to think again before buying a more expensive house.

What you're planning is the exact opposite to what many people do in their retirement: move to a smaller and cheaper home, and so free-up money to live off.

You might feel that you're wealthy enough not to have to worry about that.

But if you've got $430,000 in investments (or $530,000 and a $100,000 debt), you will probably find that the after-tax returns on it (minus mortgage interest payments) don't amount to a particularly grand income.

Keep in mind, too, that you could quite easily live another 30 years. Even though inflation is much lower than it used to be, it will still badly erode the value of your investments - and the returns they generate - over several decades.

Ideally, you should make sure your investment capital grows by inflation each year.

You could, of course, take a different tack and supplement your income by gradually using up your capital until you die. A safe way to do this so you don't run out of money would be by buying an annuity.

But at your relatively young ages you wouldn't get much of a deal on an annuity.

Okay, end of lecture. Now to the question you asked. If you do decide to upgrade your house, your first option, selling the worst of your investments, is your best choice.

For you to be better off taking out a mortgage and keeping those investments, they would have to bring in more after-tax income than you'll be paying out in mortgage interest.

If you get a mortgage at 6.5 per cent, you'd have to make more than 8 per cent before tax on the investments. With mortgage rates moving up, that cut-off point will rise.

(To work out the cut-off point, divide the mortgage interest rate by 0.805. Those in the 33 per cent tax bracket should divide by 0.67.)

It is, of course, possible to make more than 8 per cent, but only on risky investments.

That means the returns will probably fluctuate, which could be a worry in bad times. And there's certainly no guarantee that they'll average above 8 per cent over the years.

It might also be a worry to know that, with an interest-only mortgage, you'll always be in debt and always facing mortgage bills. And, now that inflation is low, that debt won't diminish much in real terms.

Taking on debt when you don't have to - especially in retirement, and especially when the borrowed money won't generate income - is not a good idea.

As far as New Zealand Super goes, you're probably wise not to count on it.

In years to come, I would be surprised to see Super reduced much for those with no other income, although the eligibility age might rise.

But I wouldn't be at all surprised to see cuts for the better-off.

Q. My lady friend just turned 65. She still has to work at house cleaning to meet her mortgage and daily needs. (No savings).

One and a half years ago, she moved from Stanmore Bay to Birkdale. Through a real estate agent and a banking friend she over-extended herself with a large mortgage at a fixed rate of 9.5 per cent for three years.

At present she has her three-bedroom home on the market. She should clear between $90,000 and $100,000. Her plan is to move to the Gold Coast, Australia, buy a unit or a small house and a suitable car and then be debt-free. She is getting advice from a brother-in-law, who is very new in real estate on the Gold Coast.

To do this she must leave behind her two sons and seven grandchildren. One son suggested for her to build a granny flat on to his property in Henderson. Or sell, then sit tight and search for a unit or small house, at no more than $130,000. She could handle a mortgage of $30,0000. Also, the banker friend would help her get the needed loan.

What would you suggest she do with the approximately $100,000 cash?

A. It's time your friend learned to be wary of advice from the self-interested - the real estate agent, perhaps the banker, and now, probably, the brother-in-law.

Mind you, it's just possible that you, too, might be acting in your own interest in suggesting she stick to this side of the Tasman! Still, I'm on your side. She's closer to family and friends if she stays in Auckland. And I doubt if her money will go as far in real estate on the Gold Coast as it will here.

There was an ad in last weekend's Herald for Gold Coast beachfront apartments from $100,000.

What it didn't say was that the price is in Aussie dollars. It amounts to about $125,000 in our dollars. What's more, the saleswoman said when questioned, the units at that price are ground-floor studio apartments.

They might be lovely. Or they might be much like standard motel units. So many New Zealanders have been burnt by Gold Coast property investments that I can't get excited about your friend's prospects.

That's not to say that she'll get a mansion in Auckland or the North Shore, either. But a quick look through last weekend's real estate section shows she could get a studio or one- or two-bedroom unit or apartment in: Mt Wellington for $119,000, Birkenhead for $135,000, New Lynn for $122,000, the inner city for $89,000, Mt Eden for $130,000, or Newmarket for $128,000.

There were also townhouses in Papatoetoe for $138,000, or Onehunga for $139,000, a two-bedroom house in Helensville for $135,000, and much more if you look through the ads more closely.

Don't forget these are asking prices. In many cases your friend could pay less, especially as she will be a cash buyer.

Other ideas she could consider are buying a slightly more expensive place and taking in a tenant or boarder to help pay off the mortgage or taking up her son's offer and building a granny flat.

That last option might be the best of all - provided she gets along well with her son's family.

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