Should you Withdraw the Maximum Amount from your KiwiSaver for your First Home?

by Alpha

We have a sky-high house price in New Zealand at the moment, especially if you are looking to buy in major cities such as Auckland, Wellington, and Christchurch. To get your first home, you will need all the help you can get. Here comes the KiwiSaver.

KiwiSaver First-home Withdrawal

A KiwiSaver member can withdraw most of their fund from KiwiSaver to pay for your first home. Here is the condition

You must have been a KiwiSaver member for three or more years.
You can ONLY withdraw money to purchase your first home – not an investment property.
A couple can both use their KiwiSaver withdrawal on the same property as long as it is their first home.
KiwiSaver members can withdraw most of their fund out but must leave a minimum balance of $1000 in your account.

Joe and Jill buying their First Home

Joe and Jill are a young married couple. They want to get into their first home. They’ve $65,000 cash saved up for their first home. They want to buy a $435k house in Wellington.

Screen Shot 2017-11-21 at 10.42.31 PM.png

The $435k Dream House for Joe and Jill

To buy that house, they will need to come up with a 20% deposit. For a $435k house, they will need $435,000 x 20% = $87,000. The cash they have are not enough for a 20% deposit, but luckily, they are both in KiwiSaver. Here is their KiwiSaver balance.

Joe joined KiwiSaver 2 years ago with the balance of $7,000.
Jill joined KiwiSaver 10 years ago with the balance of $48,000.

Since Joe only in KiwiSaver for 2 years, he cannot withdraw his KiwiSaver balance. However, they will have enough with just Jill’s KiwiSaver.

Jill withdraw $47,000 from her KiwiSaver and left $1,000 balance in her fund. They use that money and combine with their cash, they managed to buy their first home with a mortgage.

Don’t put everything in KiwiSaver

Will and Grace also want to buy a house for $400,000. They are both in KiwiSaver for 4 years, and they were contributing 8% to KiwiSaver. They had $85,000 total in KiwiSaver and kept $10,000 in their bank. If they want to get into a $400K house with a 20% deposit, they will need $80,000. They can withdraw up to $83,000 from their KiwiSaver account.

They managed to get a $400K house from an auction (Yay!) and the real estate agent ask them for a 10% deposit on that day. Will thinks ‘No problems, I’ve got that money in my KiwiSaver.’ However, the fund in KiwiSaver can ONLY use for settlement and cannot withdraw before that. The winner of the auction is required to pay a deposit on the same day, usually at 10% of the price. So now Will and Grace need to come up with a $40,000 cheque in a short time.

Withdraw Maximum or Just Enough

I’ve got a couple readers asked about KiwiSaver First Home withdraw. One of the questions is,

Should you withdraw just enough for home deposit or withdraw maximum from your KiwiSaver?

There are good reasons for both sides of the argument. If you withdraw just enough on the KiwiSaver, more money will stay in KiwiSaver, and it will provide a better return in the future. For a 10-20 years terms, the money sitting in KiwiSaver should be averaging 6-7% return after tax and fees. Compare that to the interest of your mortgage at 4-6%, it seems better to leave the money in KiwiSaver and invest it.

On the other hand, if you withdraw all the maximum amount from KiwiSaver, you can put whatever you have as your downpayment and reduce the size of your mortgage. You can also keep same mortgage amount and have more cash on hand for emergency or home improvement.

Back let’s go back to our example of Joe and Jill and see how those two options work out. Here are the basic info and some assumption for our analysis.

House Price: $435,000
20% Deposit: $87,000
Cash on Hand: $65,000
Emergency Fund Ideal Level: $10,000
Jill’s KiwiSaver Fund Balance: $48,000
Jill’s KiwiSaver Monthly Contribution (include employer and MTC): $277.17
KiwiSaver Fund Long Term return (after tax and fees): 7%/year
Home Loan Interest rate average: 5.5%/year

Options 1 – Withdraw just enough

They will keep $10,000 cash on hand as an emergency fund and put $55K toward the deposit. They also withdraw $32,000 from Jill’s KiwiSaver fund to make up the 20% deposit. Here is their financial breakdown

Mortgage: $348,000 (30 years term)
Minimum Mortgage payment: $1,975.91/month
Cash on hand: $10,000
Jill’s KiwiSaver Fund Balance: $16,000

Options 2 – Withdraw maximum

They will keep $10,000 cash on hand as an emergency fund. They put their remaining cash ($55k) plus withdraw the maximum amount ($47k) from KiwiSaver toward to their downpayment ($102k). The mortgage amount will reduce to $333k, but they will pay it off as a $348k mortgage.

Mortgage: $333,000 (30 years term)
Minimum Mortgage payment: $1,890.74/month
Actual Mortgage payment: $1,975.91/month
Cash on hand: $10,000
Jill’s KiwiSaver Fund Balance: $1,000

30 Years down the road

In option 1, Joe and Jill will pay off their mortgage in 30 years while Jill’s KiwiSaver growth from $16,000. Here is the breakdown:

At the end of the 30 years, they will fully own their house, and Jill’s KiwiSaver’s balance is $468k.

In option 2, Joe and Jill will pay extra on their mortgage every month, and they will pay it off in 27 years. Once the mortgage is gone, they pay extra into the KiwiSaver.

At the end of 30 years, they fully own their house, and Jill’s KiwiSaver’s balance is $425k.

Not a clear cut answer

Based on the numbers, option 1 will have a better financial position compared to option 2. We already know that from the beginning because we set the after-tax return on KiwiSaver at 7% and mortgage interest at 5%. KiwiSaver and investing will always come out on top when you compare the number this way.

However, after I understand about risk and being a first home owner for couple years, I will prefer to reduce the mortgage (option 2).

First, there is always risk associated with investment because you’ll never know whats gonna happen. The long-term average return will be 7%, but that is based on past performance. We should keep in mind that past performance is no guarantee of future results. For all that we know, our investment maybe heading 10 years of negative returns. Also, the mortgage interest rate is not guaranteed as well. Past data shows the interest rate is at the historic low so there is real possibility it will go up. On the other hand, the return from paying off your mortgage is guaranteed and tax-free.

There is the risk in investment. Also there is the risk in life. Being a first-time homeowner with a mortgage, it will put you in a position that you’ve never been (for most people anyway) – you are DEEPLY in debt.

Before you purchase your first home, you may be someone with not much asset and a little or no debt. Once you’ve bought the house with the mortgage, you are now partly own a big asset (the lender still own the most), had a mortgage 5-15 times of your annual income, don’t have a lot of cash on hand and a big part for your income went to mortgage repayment. Financially you are in a vulnerable situation. If something happens with your life like job loss, sickness, accident or something you’ll need to fix on the house, you may be short of cash. You should avoid being in this situation by having a smaller mortgage (pay more on deposit) or have more cash on hand.

Some personal experience here. Wife and I found out we are having our first baby just 1 week after we won a house in an auction. All of our budget plans are out of the windows. We were down to one income for couple month as a new house owner. Luckily, we did one thing right on our mortgage was putting over 20% down payment on our house while the bank was advertising 5% deposit. With a bigger down payment, come with a small mortgage and a smaller minimum payment. We were managed to get through that period with careful planning and frugal living. I can’t imagine what sort of pressure we will be in if we just put down 5% deposit and borrow 95% on the house.

Based on those reasons, I personally prefer getting the maximum amount out of KiwiSaver and put it toward mortgage or keep it on hands for at least 1 year.

It’s better to withdraw Maximum

Your situation and risk appetite may be different than mine, and you may prefer to keep the money in KiwiSaver for your retirement. However, I will still recommend you withdraw the maximum amount no matter what choice you’ve made.

The reason is you can only withdraw from KiwiSaver once, but you can always put your money back in later. By having more cash when you move into a new house, it will help you to deal with any unexpected situations.

Let’s go back to our example of Jill. Jill’s KiwiSaver balance is $48K, and the maximum amount she can withdraw is $47K. She may decide to put down 20% deposit, just withdraw $32K and keep $16K in KiwiSaver for retirement (option 1).

I would suggest she still withdraw $47K out and put $40k from their cash for their 20% deposit. Now they will have $25K cash on hand and $1,000 in Jill’s KiwiSaver. She will hold on to that cash for 6-12 months to make sure their house is in order, and there is no major repair required. If everything’s fine and Jill still prefers to invest with KiwiSaver, she can put it back into her KiwiSaver after 12 months as KiwiSaver allows members to make manual contribution anytime.

How can You decide

There is a simple way to help you decide to keep the money in KiwiSaver for retirement or help reduce your mortgage.

Imagine you fully own your house today with no mortgage at all. Will you borrow $X on your house to invest in KiwiSaver for your retirement and won’t get it out until you are 67? (X is the difference between withdrawing everything and just enough. In Jill’s case, that will be $15,000.)

What I did was reserve the situation and let you look at the question from the other side. Mathematically, invest your available cash in KiwiSaver and not paying off your mortgage is the same as borrowing on your house to invest in KiwiSaver. Once I frame the question this way, you will feel the security of owning your house and the risk of investing.

Other Support from KiwiSaver

Apart from First Home Withdrawal, KiwiSaver member may be qualified for KiwiSaver HomeStart grant. Check out the information on Housing New Zealand site or contact your KiwiSaver provider.

I will continue to write more about mortgage in the coming days. There is a mortgage set up that allows the homeowner to reduce their mortgage amount while having access to cash if they need to. So stay tuned for my blog post on the Best Mortgage structure for most homeowners in New Zealand.

July 21, 2017 Mortgage Interest & Principal, New Zealand, Personal Ffinance 5 Comments

Understand Interest & Principal on Your Mortgage Payment

by Alpha

Do you know how much interest you are paying on your mortgage? No, I am not talking about the interest rate. How much interest in the dollar amount you are paying on your mortgage? Also, what proportion of your mortgage payment goes to interest? Do you know how many years it will take to pay off half of your mortgage? (spoiler: more than 20 years with 5% interest rate)

Most home owners know their mortgage payment like the back of their hand, but not all of them can tell you how much interest is in the payment. Some new house owner is surprised when they read the mortgage statement and found out how little money went to mortgage repayment. Let’s look at the interest and principal on our mortgage payment. I will be focus on the simple interest mortgage with a fixed interest rate and fixed payment amount for 30 years.

Interest and Principal

Every mortgage payment in New Zealand will contain Interest and Principal.

The principal is the part of your mortgage payment that goes to repay the amount you borrowed. It starts out with a small amount and increases on every payment. Eventually, the total principal paid will be equal to the amount you borrowed.

The lender (usually Bank) took up risk to borrow you money on a house purchase. Interest is the reward for taking that risk. They are profit for the lender and expense for the borrower. Interest rate could be different for each different borrower. Usually, a low-risk borrower will have a lower interest rate compared to a high-risk borrower. At the lender’s point of view, to take a higher risk borrower, they will charge higher interest to compensate that risk. A significant amount of mortgage payment will go to interest payment at the beginning of the mortgage and decrease on every payment.

Screen Shot 2017-07-20 at 2.23.05 PM.png

Proportion of interest and principal on a 5% interest, 30 years mortgage

How Much Interest you are paying?

We will use the following simple interest mortgage as an example.

Mortgage size: $500,000
Term: 30 years, pay monthly
Interest rate: 5%
Monthly payment: $2,684.11

For your first payment, $2083.33 will go to interest and only $600.77 will go to principal payment. That’s 77.6% of your monthly payment go to interest expenses.

Screen Shot 2017-07-20 at 2.26.01 PM.png

Breakdown on your mortgage payment during the first year

For the first year, you will pay $32,209.30 in mortgage payment, $24,832.47 will go to interest, and you only reduce your mortgage by $7,376.83.

Why most of your payment went to interest in the beginning?

You may be surprised only 23% of your mortgage went to principal payment and wonder why most of your payment went to interest in the beginning. I was angry and thought it wasn’t fair. So I dug in and worked out how the banks come up with that amount.

First, under the terms of the mortgage, interest is calculated daily and compounded monthly. What it meant was the bank will charge interest on the mortgage every day and recalculate the mortgage amount and interest every month. The interest rate (5% here) is an annual rate, so one day of a 5% interest will be 5% / 365 = 0.013699%. Bank will apply that one-day interest rate to your current mortgage amount $500k. At your first month, you will be paying $500000 x 0.01369% = $68.49 every day on interest. Here is the daily breakdown on the first month of the mortgage.

You may notice on 31/7, the interest amount is only $28.54. The reason is that when we calculate the monthly mortgage payment, we are not calculated based on how many days in a month. We just divided the full year (365 days) by 12, so every payment got 30.41667 days. That’s why I have to re-adjust the 31st day of July interest by 0.41667. $68.49 x 0.41667 = $28.54.

On 31/7, you pay $2684.11 for your mortgage. At this point, the total interest is $2083.33, only $2684.11 – 2083.33 = $600.77 go to reduce the $500K mortgage. At 1/8, your new mortgage amount will be $499,399.89 and you daily interest will be $499,399.89 x 5% / 365 = $68.41. At the end of the month, we will accumulate $2080.83 in interest. By paying the same amount of mortgage payment ($2684.11), you will reduce the mortgage by $2684.11 – 2080.83 = $603.28.

When you compare the numbers on both months, your monthly payment amount is the same. Since you reduce the mortgage amount by a little bit in your first payment, the interest on the mortgage at the 2nd month will be reduced. That explains the interest payment will keep decreasing and principal payment keeps increasing. The reason we why most of your payment went to interest payment is because your mortgage amount is high in the beginning. Lots of interest was charged and most your payment went to pay off those interest.

How does pay extra on your mortgage reduce the interest calculation

In my last post, I said one thing you can do to reduce the interest paid on your mortgage is by paying extra on the mortgage. Let put that in our example and see how $100/month extra can reduce the interest.

The first month will be the same as we haven’t made any payment. We will still have $2083.33 interest needs to pay. However, if we increase the monthly payment to $2183.33, we will reduce the mortgage amount by $2183.33 – 2083.33 = $700.78. On your second month, the new mortgage balance is $499,299.22 and the daily interest will be $499299.22 x 5% / 365 = $68.40. At the end of the month, we will accumulate $2080.41 in interest, $0.42 less.

You may think that just $0.42, hardly make any difference. However, that is the saving on the second month only. You will save more and more each month. Paying extra on the mortgage will have a knock on effect on the mortgage amount reduced. You will end up pay off your mortgage in 27.6 years and saved $42.6K on interest.

Breakdown interest paid by years

Now we took the $500K mortgage break it down by years. Here is what you will pay over 30 years.

Some interesting facts here:

77% of your first-year payment went to interest.
By the end of the mortgage, you will pay $500K on principal and $466.3K on interest. You almost paid twice on your mortgage.
For the first 16 years, over 50% of your payment will go the interest.
You will pay almost half of the total interest on the mortgage in your first 10 years. Therefore, lenders make half of their profit in 1/3 of the time.
After paying 20 years, you still owe over 50% on your mortgage.
You will pay off $253K in the last 10 years of the mortgage.

That’s why Bank love mortgages, and it’s their bread and butter. I personally feel angry reading those facts. I put reducing mortgage as my top financial priority. On the other hand, inflation is another factor helping to reduce the ‘real’ cost of the mortgage, we will get into that in another post.

If you want to find out the breakdown on your mortgage payment, you can check out this mortgage calculator on mortgagerates.co.nz.

Email thesmartandlazy@gmail.com or follow me on Twitter @thesmartandlazy if you have any questions.

SaveSave

July 13, 2017 Mortgage New Zealand, Personal Ffinance, property, Reducing Mortgage 1 Comment

Understand the Math of Mortgage

by Alpha

I spent a lot of time here talking about investing in New Zealand. However, if I put my money where my mouth is, I spent more money on reducing my mortgage compares to investing. So let’s take a break from investing and talk about the mortgage, which is one the top three investment options in New Zealand.

We are one of the lucky ones who luck into a house before house price went batshit crazy between 2013-2016. However, since we brought Auckland, the mortgage amount is still huge dispute we put down more than 20% deposit. So reducing that mortgage have been my top priority and I spent a lot of time to research and study on mortgages. It turns out the mortgage is just a mathematical formula. If we understand the factor of that formula, how to pay off the mortgage early is not a secret at all.

The Formula of Mortgage

A mortgage is a loan to buy a property. You borrow money from the lender (usually a bank), and you are obliged to pay back with interest. The lender uses the property as security. Here is the formula of Mortage.

A is the payment on each term.

L is the mortgage amount (or Principal)

r is the interest rate

n is the term

So the mortgage formula based on those four factors and they are interconnected. If you follow the mortgage plan and make the payment each term (usually every fortnight or month), by the end of the term, you will pay off the mortgage and plus interest.

(You don’t need to calculate the mortgage on your own. There are hundreds of mortgage calculator online, I recommend the Mortgage Calculator on Sorted)

Interest and Principle

Each mortgage payment will have interest payment and principal payment. The principal is to repay the amount you borrowed, and interest is profit for the lender. At the beginning the mortgage term, most of the payment went to interest, and only a small part of the payment went to the principal.

To work out the total interest paid on the mortgage, you will need to:

Payment amount X No. of Terms = Total amount paid

Total amount paid – Mortgage Amount = Total Interest Paid

The Game of Mortgage

The mortgage is a game with four controls.

For me, the mortgage is just a game. It’s a game with 4 controls. The goal of the mortgage game is to minimise Total interest paid by changing payment amount, mortgage amount, interest rate and terms within your abilities. In New Zealand, the size of the mortgage can be range from $100k to $1mil or more. Total interest paid on the mortgage can be 30% – 130% of the size mortgage. This is a high stake game with $30k to $1.3mil of interest to be saved. Yet, the rule of the game is surprisingly simple!

We are going look into each factor and see how they affect our goal to minimise our total interest paid. We will be using the following mortgage as our default example. To keep it simple, I assume interest rate will stay the same during the whole period.

Mortgage size: $500,000

Term: 30 years, pay monthly

Interest rate: 5%

Monthly payment: $2,684.11

Total Interest Paid: $466,278.92 (93% of mortgage size)

Mortgage Amount

The mortgage amount is the main deciding factor in a mortgage. The amount you borrowed is in direct proportion to your monthly payment and total interest paid. More you borrow, more you pay every term and more paid on interest. However, the size of total interest paid compared to mortgage amount reminds the same. In our example, no matter the size of the mortgage, you are still paying 93% more on interest.

In most case, you want to borrow as little as possible.

Screen Shot 2017-07-12 at 9.27.57 PM.png

5% interest rate and 30 years term, pay monthly

Interest rate

Interest is charged by the lender to the borrower to offset the risk of lending money. It calculated based on interest rate. Interest rate change from time to time due to multiple factors, including official cash rate change by RBNZ, the cost of borrowing at the lender, the length of the fixed term, demand of mortgage at each lender and more.

Increase interest rate in a mortgage formula will affect mortgage payment and total interest paid. If you took a 5% interest rate and increased that by 0.5% to 5.5%, the mortgage payment will increase by 5.8% but the total interest paid to mortgage ratio jump from 93% to 104%. So you want your interest rate as low as possible.

Screen Shot 2017-07-12 at 9.32.58 PM.png

$500,000 Mortgage, 30 years term, pay monthly

Terms & Payment

The term is how long the mortgage supposes to last and payment is how much you will pay each time. I put them together because they are closely connected in a mortgage. If we increase the mortgage terms, the payment amount will be lower but you will pay more on interest. On the other hand, if we increase the payment amount, we will shorten the mortgage terms.

In the table below, you can see if we shorten the mortgage by increase our payment amount, we will be paying a lot less on interest.

Screen Shot 2017-07-12 at 10.12.39 PM.png

$500,000 Mortgage, 5% Interest Rate

In Reality, What can you Change?

Now we understand those four factors of a mortgage and how they will affect the end game (a.k.a total interest paid). Let’s put them into a real world situation and see how we can change them to our favour. (There are many ways to improve those factors, I only covered the obvious one here)

Reduce Mortgage Amount

Since the mortgage amount decides your term payment and total interest paid, it’s better to have a smaller mortgage. With small mortgage amount, it will come with a small monthly payment amount. You can increase the monthly payment amount without adding pressure to your living budget.

To reduce the mortgage amount for potential house buyer, you will have to put down a larger down payment or choose a cheaper house.

For existing homeowner, you can reduce the mortgage amount when you mortgage terms are up for review by transfer some of your saving to repay that mortgage. (if you have the spare cash)

To be honest, it is difficult for both potential buyer and house owner to reduce their borrowing amount. With those crazy house price these days, most of the potential buyers are stretching to the maximum on what they can borrow and get onto the property ladder. Existing homeowners are already stuck with that mortgage and lender don’t like you pay them back early. So in reality, you don’t have much control on that.

(There are some tricks to reduce that mortgage with right mortgage set up. We will get into that in an upcoming blog post)

Get a Better Interest Rate

Bad news, you don’t have much control on interest rate either. The Interest rate set by the lender and each lender will have the identical interest rate. What you can do is make yourself a better borrower.

Banks love mortgages as this is their bread and butter. If you are a good borrower in their eyes, they will offer you a discounted interest rate to get your mortgage business. What consider a good customer from the Bank:

Owner Occupied Property, mean the mortgagor live in that property
Work full time with a stable income
Employed by established company for a long time
Clean credit history
No other debt
DINK (Double income, no kids)
New Customer
Willing to change your ‘Main Bank’
Have 20% or more equity in the house
A good quality house in a good location (not leaky home or potential leaky home)

Bank will consider that as a low-risk lending and happy to offer a small discount on the interest rate.

However, the free-market is still the primary deciding factor on the interest rate so there is not much we can do about that. Kiwis used to pay 18% interest rate in 1985. Before GFC in 2008, the mortgage rate was around 8.4%. We are experiencing a historic low in interest rate at 2017.

Increase Payment Amount & Shorten the Terms

Payment and terms are the most important factor in the game of mortgage because we have control over it. When the bank says you need to pay $2684.11 for your $500K mortgage, it’s not the absolute amount! It’s just the minimum amount you’ll need to pay. You can always tell the bank you what to pay more. Let’s see how the term and total interest paid change when we pay more on our mortgage.

Screen Shot 2017-07-13 at 9.28.40 AM.png

$500,000 Mortgage, 5% interest rate. Minimum monthly payment at $2684.11.

By simply put $1/day extra into your mortgage payment ($30/month), you will shorten the mortgage by 9.6 months and save $13.8K on interest. If you can add $10/day extra into your payment, you can pay off your 30 years mortgage in 24 years and saved $106,644 in interest.

It may be hard to do in the first couple of years, but your income will likely to be increased while the mortgage payment stays the same. Combine that with careful budgeting and frugal living; you can put more and more into your mortgage and reduce the interest paid.

The Secret of Paying off Mortgage

Now you understand the four factors of the mortgage and how you can improve them. The secret of paying off mortgage fast and win the game of mortgage is very simple.

Get the smallest amount of mortgage with the best interest rate discount, pay it off with the biggest payment amount you can afford.

That’s the fundamental principle of getting out of debt; it does not only apply to the mortgage but other consumer debt as well. Every single tips and trick that help you pay off mortgage fast will always chase back to this principle. We will cover lots of them in the coming months. Stay tuned.

Email thesmartandlazy@gmail.com or follow me on Twitter @thesmartandlazy if you have any questions.

July 6, 2017 Debt, Investing, KiwiSaver, Mortgage, Personal Finance Basic New Zealand, Personal Ffinance 6 Comments

Top 3 Investment Options in New Zealand

by Alpha

I spent a lot of time on my blog talking about ETF and index fund investing in New Zealand. I believe they are great options and an import investment vehicle to help me achieve financial freedom.

However, there are three investment options are objectively better than ETF and Index fund with low entry requirement, low risk and high (sometimes guarantee) return. They are the low hanging fruit of personal finance that everyone should do it. Those three investments options are pay off consumer debt, join KiwiSaver and reduce the mortgage. I will go through each one of them and talk about they risk and return.

No.1 Pay off Consumer Debt

You want to kill those consumer bills ASAP!

Credit card debt, car loan, payday loan, personal loan, hire purchase, P2P loan… All of those are consumer debt. Debts that are owed as a result of purchasing goods or services that are consumable and do not appreciate in value. Those debts usually have high-interest rate and exorbitant admin fee. If you are paying interest on depreciating assets, they are dragging back you financially. You won’t go forward if most of your income goes to those stupid bills. You need to get rid of them ASAP!

Paying off debt is Investing

This concept may not be obvious to everyone but PAYING OFF DEBT IS INVESTING. For me, debt and investing are just two sides of the same coin. One side (investing) is to increase your wealth (with a given level of risk). Like you buy NZ Top 50 ETF from SmartShares, if the share price increase and they pay out a dividend, your wealth increased. On the other hand, the shares price may drop, and your wealth will decrease. So there is a risk of losing money with investing.

The other side of the coin (debt) will reduce your wealth. If you have $1000 credit card debt with 20% interest, your interest expense for the first month will $16.67. So your wealth reduced by -$16.67. Unlike investing, the debt will guarantee to reduce your wealth and drag you back financially. Therefore, reduce your debt will move you forward financially, guaranteed.

Whats the return and risk?

I will use a simplified sample to present the financial effect of paying off debt.

Assume you have $1000 in cash and $1000 credit card debt with 20% interest. If you keep the $1000 in cash and don’t pay it off credit card debt, in one year, you will be $1000 x (1 + 20%) = $1200 in debt. Financially you moved backwards by $200.

Now, you invest the $1000 cash in a 12 months term deposit with 3.25%. You still keep your $1000 credit card debt and not paying that off. In one year, your earn $1000 x 3.25% = $32.5 in interest from your term deposit. Take away $9.75 as tax; you will have $1022.75 in cash. On the other hand, your credit card debt still cost you $200 in interest. So financially, you moved backwards by $177.25.

Instead of invest that $1000 into a term deposit, you use that $1000 to pay off your credit card debt. Since the credit card debt is gone, it won’t occur interest. In one year, you will be in the same financial position.

Look at all three scenarios, pay off credit card debt resulted in the best financial position. As you putting that $1000 cash to pay off your credit card debt, you are in fact getting 20% return on those $1000. Unlike other investment, those returns are Tax-free and guaranteed. If you need to get 20% after-tax return on investment, the pre-tax return will need to be 27.77%. That is an excellent return on investment. I am not saying you can’t get 27.77% return out there, but I am sure there is no investment (except KiwiSaver) can guarantee a 27.77% with no risk.

If we look that those high-interest-rate consumer debts, paying them off will be a great return for your money. Also, paying off consumer debt will reduce your financial risk and stress. You will be in a much better position when you negotiated mortgage term and resulted in better deals. That why paying off consumer debt is one of the top three investment options.

What about Student Loan?

The student loan in New Zealand is interest-free as long as you are staying in the country. The payment only occurs when you have income. So you should just pay it off as you’ve got income. I would not be paying them off early unless you plan to leave the country for a long time.

No. 2 – Join KiwiSaver

KiwiSaver is a voluntary, work-based savings initiative to help you with your long-term saving for retirement. It’s designed to be hassle-free, so it’s easy to maintain a regular savings pattern. Once you join KiwiSaver, at least 3% of your income will invest into a KiwiSaver fund. You can only access those fund until you use it to buy your first home or turn 65. What makes KiwiSaver to be a top investment option is because of employer contribution and member tax credit.

Employer match

If you’re over 18 and is a member of KiwiSaver, when you make your KiwiSaver contribution, your employer also has to put money in. By law, the employer required to contribute at least 3% of your income. The employee can choose to contribute either 3%, 4% or 8% but employer only requires to match at 3%. Some employer may decide to match 4% or 8%.

It may seem you will be making 100% return on investment on your 3% contribution. However, IRD will take out tax from you employer contribution, so the actual return on your contribution is about 67%-89.5%. (You can find out why here) It’s still an unbeatable risk-free guaranteed return.

Member Tax Credit

KiwiSaver Member Tax Credit is to help you save on your KiwiSaver. The government will make an annual contribution to your KiwiSaver fund (a.k.a Free money). The amount is $0.5 on every dollar up to $521.43. You will have to be 18 or above to receive the tax credit. This is a way of government help you save for your retirement and encourage you to join the plan. It cap at $521.43 so it will benefit for the most full-time employee but not favour mid to high-income earner.

Return on Employee

If you are over 18, fully employed, annual income at $55,000 before and contribute at 3%. Your minimum return on your contribution will be like this.

Your annual contribution (3%): $1650

Employer contribution after tax: $1361.25

KiwiSaver Member Tax Credit: $521.43

The return on your investment: (1650 + 1361.25 + 521.43 – 1650) / 1650 = 114%

Return on Self-Employed

If you are self-employed, you won’t get the employer match, but you are still entitled to member tax credit as long as you make a minimum manual contribution for $1042.86

Your manual contribution: $1042.86

KiwiSaver Member Tax Credit: $521.43

The return on your investment: (1042.86+ 521.43 – 1042.86)/ 1042.86 = 50%

Those are only your base return; you are likely to make investment return on your KiwiSaver Fund as well. Here is a couples data on a KiwiSaver fund with different income level. The KiwiSaver fund cost and return data are based on SuperLife 80.

No. 3 – Reduce your Mortgage

Mortgage payment can easily be the biggest expenses on most homeowners’ budget. Average first home buyer will spend $1500/month on the mortgage, and it will cost more if you have a mortgage in a major city. Imagine what you can do with that money if you don’t have a mortgage payment.

Return on Reducing Mortgage

Paying off have the same effect on paying off consumer debt. It will give you a tax-free and guaranteed return. The return is not as high as those consumer debts because the interest rate on the mortgage is lower at 4% – 6%. The equivalent pre-tax return is around 8.3%.

Reduce your Mortgage or Invest elsewhere

Some people may think 7-8% is not a very good return, and you can achieve that with other investment options without taking a lot of risks, like the share market. However, I still think paying off the mortgage on your own home is a better option because you are paying off an asset that will provide you with a place to live, offset the cost of renting in the future and the house will increase in value (in the long term for most cases).

If you can’t decide to reduce mortgage or invest elsewhere, ask yourself a simple question:

If you fully owned your house today, will you borrow $500k on your mortgage-free house to invest in share market? Or you will use your income to invest in the stock market every month?

If you say you won’t borrow on your mortgage-free home (like me), then you should focus on reducing that mortgage now. I basically asked the same questions but put it in a different perspective. If you have the money to reduce the mortgage, but you put it into the share market, you are basically borrowing on your house to share market.

Saving Big on interest expense

Since the mortgage size is usually over $200K (over $500k in Auckland) and the payment terms are 20-30 years. You end up paying A LOT on interest expenses. Check out the chart below.

For a 30 years term mortgage at 5% interest rate, you will end up paying 93% extra for interest payment. So what will happen if we increase our payment and shorten the mortgage by ten years?

When we shorten the mortgage term by ten years (-33%), our monthly payment increased by 23%, total interest paid decreased by 37.3%! Only 36.9% of your payment went to interest.

Reducing mortgage may not give you a high percentage return, but due to the size of the mortgage, the saving you are likely to make is in the hundreds of thousands. I will have a series of blog posts in the coming month to show you how to be smart on your mortgage with different setup and tips.

Conclusion

The top 3 investment options in New Zealand are paying off consumer debt, join KiwiSaver and reducing your mortgage.
Paying off consumer debt is investing. The returns are in the range of 15% – 35%. You will be in a better financial position once you pay off your debt.
A KiwiSaver member can enjoy instant return from minimum 50% – 110% due to member tax credit and employer match. However, that money is locked-in until you purchase your first home or turn 65.
Paying off return about 7% – 8% on your dollar, not as high compared to other. However, due to the size of the mortgage and interest paid, you are likely to be saving hundreds of thousand of the dollar

Email thesmartandlazy@gmail.com or follow me on Twitter @thesmartandlazy if you have any questions.

March 27, 2017 Mortgage, Personal Finance Basic Banking, First home, First home buyer, Insurance, Mortgage, Mortgage broker, New Zealand 5 Comments

10 Mistakes I made as First Home Buyer

by Alpha

In this blog post I listed 10 mistakes that I made as a First home buyer. Now, here are more details about what I’ve done wrong.

I walked into my bank and get the personal banker to do my mortgage.
You can get a better deal and service from a mobile mortgage manager for that bank or a mortgage broker. A good mortgage broker will not only get you a deal on interest and cash back, they can also help you to structure a home loan so you pay it off faster. Moreover – if you are getting a quote from the bank, don’t ask just one bank. Make sure you get at least 3 quotes and be prepared to switch banks to get the best deal for you.
I took the advertised rate.
Bank’s advertised rates are for SUCKERS! You should ALWAYS ask for a lower rate. If you can’t get a better rate, ask another bank. There is 95% of the time you will get a lower rate unless you are a ‘high risk’ lender. Do not settle for the advertised rate. And remember – both fixed and floating rates are negotiable.
I 100% fixed my mortgage.
100% fixed mortgage gives certainty on your payment so lots of people are taking that. However, you will end up with extra cash sitting in a saving account and earning low interest. It would be better to set up a small revolving credit or offset mortgage for that cash to offset the home loan interest. You will be paying less interest while having the flexibility of cash in your account.
I paid my mortgage based on what the bank said.
If you have a 600K, 30 years term mortgage at 4.79%, the bank will ask you to pay $3144.37 monthly. Keep in mind that amount is NOT the absolute amount, it’s just the MINIMUM amount you should pay. You can (and should) always ask to increase the payment amount. Even a $50 increase or rounding up to the nearest $100 can save a lot of interest and time (I am talking about years) on your mortgage. For instance, If you up the 600k payment to $3250/month ($106 extra/month, just$3.5/day), we will reduce the loan by 2 years and save $42611 on interest.
I pay monthly.
You will save more on interest if you pay fortnightly. Using a 600K loan as an example, the monthly payment will be $3144.37. If you pay fortnightly, the payment amount will be $725.12. The annual amount when paid monthly is 3144.37 x 12 = $37732.44, compared to a fortnightly payment of $725.12 x 52 = $37706.24, a $26.20 different. Although the amount is small, a saving is saving.
I accepted the $1000 cash back.
This is the same principal as point no.2; you should always ask for a better deal. Although it may not be that easy to get more cash back at the moment.
I did not get a friend to do a referral despite heaps of my friends are with that Bank.
My bank, at that time, offered $500 cash if you got your friends and family to start a mortgage with them. I could’ve got friends to do a referral and split the $500.
I buy insurance from the bank.
Insurance from the bank is more expensive compared to insurance companies while offering a similar service. In my case, it was about 20% different. It is very easy to get an online quote for home, content and life insurance now.
I did not ask for fee-free credit card
Again, this is the same principal as no.2, you may not get it but at least you asked.
About 18 months into that fixed term, some news headline saying interest rate is going up. I considered to break the contract and refinance.
I didn’t in the end. However, I shouldn’t have been affected by a couple of news headlines or what the radio says.

So, those were my rookie mistakes when I first started my mortgage. Hope you guys won’t make the same mistakes that I made. Now, my mortgage set up is optimal for my situation and I will write about it in a coming blog post.

Email thesmartandlazy@gmail.com or follow me on Twitter @thesmartandlazy if you have any questions.

March 18, 2017 Mortgage Banking, house buying, Insurance, Mistake, Mortgage, New Zealand, property 10 Comments

My First mortgage as a noob

by Alpha

I was sorting my paperwork and saw my old mortgage paper. I was such a noob back then and made a lot of mistakes when I set up that mortgage.

Hunting for our First home

When I and my wife start hunting for house couple years back, we’ve done the first timer mistake by walking into my friendly local bank which I’ve been banking with for 10+ years, ask about home mortgage and got introduced to a personal banker. Had a 30 mins meeting where the banker took our account statement and worked out our income, expense, and deposit. We walk away with a 600K loan pre-approval.

So, we went on to house-hunting and luckily got a house at auction (passed-in then negotiate). We took the purchase agreement to went to the bank again. This time stayed there for an hour. Got a 500K fixed 2-year at the advertised rate home loan, pay monthly plus a life insurance for both of us, house and content insurance. I was so proud of myself because I also got a $1000 cash back and used that to pay the lawyer. The mortgage payment was about $2400/month plus $180 for the insurance. I remember when I walk out of that bank I felt a sense of accomplishment. I knocked down home ownership, mortgage, life, content, and house insurance on the same day.

The list of stupid things that we’ve done.

Now I look back at the mortgage statement, I was such a NOOB!!!! I’ve made so many first timer mistakes!!!

I walked into a bank and get the personal banker to do my mortgage.
I took the advertised rate.
I 100% fixed my mortgage.
I pay my mortgage based on what the bank said.
I pay monthly.
I accepted the $1000 cash back.
I did not get a friend to do a referral despite heaps of my friends are with that Bank.
I buy insurance from the bank.
I did not ask for fee-free credit card
About 18 months into that fixed term, some news headline saying interest rate is going up. I considered very hard to break the contract and refinance.

The ONLY thing we did right was the downpayment. At that time, you can get a home mortgage with just 5% deposit and lots of people did that. We decided to put over 20% as deposit since we saved up some money already.

At that time we didn’t know much about mortgage….actually, we don’t know much about money, personal finance, saving and spending at all. We were stuck with this deal for 2 years and within that time, we had a money crisis that forced me to educate myself about money. I read books from the library, research online, builds home loan model in excel and ran a bunch of analysis. Now I have a nice setup on a home mortgage with every dollar working to reduced the interest expense.

I am interested to know any of you made those mistake when you first took on a mortgage?

Also if you don’t know what I’ve done wrong or you actually doing the same thing, check out this blog post and I will explain what I’ve done wrong.

Email thesmartandlazy@gmail.com or follow me on Twitter @thesmartandlazy if you have any questions.