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This was published 11 months ago
I’m often asked why I choose to only make the minimum repayments on my mortgage.
It’s an excellent question, so let me explain my thinking.
Credit:Dionne Gain
When I first took out a mortgage nearly two years ago, I certainly did make extra payments to pay down the principal of my loan faster. Lots. Not only did I deliberately set up my re-occurring transfers to be much higher than the minimum required, I also socked away any extra savings into my mortgage offset account.
Unaccustomed as I was to such a high level of debt, my overriding goal was to get rid of it ASAP.
I also wanted to release my parents from their guarantee of my loan as quickly as I could. When I bought my first home in late 2019, I lacked the full 20 per cent deposit – I had about 15 per cent.
To avoid paying expensive Lenders Mortgage Insurance, I had to get my parents on the hook for the missing 5 per cent. They didn’t have to guarantee the whole value of my mortgage, mind you – just the missing 5 per cent, which on my purchase price of $870,000 was about $45,000.
If anything had happened – and I couldn’t make my mortgage repayments – the bank would have gone after my parents for the money. I didn’t like the idea and put as much towards paying down my loan as I could, with a goal of getting my loan-to-valuation (LVR) ratio below the 80 per cent needed to discharge them.
As it turns out, rising home values did most of the work for me, and I was able to release them as guarantors on my mortgage after only about half a year. Phew.
Since then, I’ve revised my strategy and have been making only the minimum payments required by my lender.
After nearly two years with a mortgage, I’ve developed a laser-like focus on my living expenses and am highly confident I can comfortably service my debt obligations.
I also know that, mortgaged or not, I still get to enjoy the full tax-free gain on my property’s value. That is locked in.
I’m also living in a property I’m happy to retire in, so there is no need for me to build up equity in this place so I can upgrade to another.
While I’d still like to own my home outright by retirement, I’ve realised I’d like to own a lot of other assets, too, to support my living standards when I do stop work.
So, I’m no longer rushing to be “debt free” and am instead regularly investing my monthly savings, via a combination of maxing out my tax-concessional super contributions and also directly investing in shares. (I’m also looking at borrowing more to invest in property, but that is a story for next week. Stay tuned.)
Of course, shouldering a higher level of debt means accepting more risk. If you lose your job or can’t make payments, you can get in all sorts of trouble.
But higher risk is also associated with higher returns, over the long run and following a sufficiently diversified strategy.
It’s true paying off my mortgage faster would mean I’d end up paying less interest to the bank over the (shorter) life of my loan than otherwise. However, that saving must be weighed against the potential gains to be had by investing the surplus savings elsewhere.
Ultra-low interest rates have radically changed that equation in recent years.
It’s easy to forget that just a decade and a half ago, before the Global Financial Crisis (GFC), mortgage holders were paying interest rates of 8 or 9 per cent.
Mortgage interest payments as a share of disposable incomes hit a high of 10 per cent just before the GFC, according to Grattan Institute figures. They have since fallen to about 4 per cent as rates have tumbled to record lows.
Truth is, once you get a foot in the door with a big enough deposit, the cost of servicing a mortgage has fallen dramatically – back to where it was during the 1980s and 1990s (property was cheaper then, but interest rates were much higher).
Today’s ultra-low interest rates (mine is locked in at 1.84 per cent for two years) have two relevant consequences.
First, as discussed, they make it much cheaper to service a mortgage.
The second impact has been to massively inflate asset prices – both property and shares.
Why? Because people are rushing out and borrowing a heck of a lot of cheap money to buy assets, inflating their prices.
How long can it go on? Well, that depends how long interest rates stay so low.
The Reserve Bank of Australia has said it does not anticipate raising official interest rates until 2024.
Global markets had been flirting earlier this year with the idea of a post-pandemic boom in global inflation. However, COVID-19 continues to cast its long shadow.
Even once we do emerge from the coronavirus cloud, we may only return to a world of “secular stagnation” and tepid wages growth that preceded it, driven by deeper forces such as ageing populations.
So yeah, I guess I’m taking a punt that this story has further to go, of lower interest rates pushing up borrowing levels and prices. If that outlook changes, I’ll review. You must form your own opinion and borrow and invest accordingly.
One common thing I hear is: “I’ll just pay off the mortgage and then I’ll get serious about investing for retirement”.
And yet, by delaying the purchase of investments for 10 to 20 years, people miss out on potential capital gains during that time – not to mention the magic of compounding returns.
Ultimately, it comes back – as it always does – to what your goals and risk tolerance are.
But for those with substantial mortgage buffers and plenty of time still left until retirement, it might be worth having another look at your strategy for building wealth.
You can follow more of Jess’ money adventures on Instagram @moneywithjess and sign up to receive her weekly email newsletter via The Age here or the Sun-Herald here.
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