Frances Cook: How to free yourself faster from your mortgage

With all the obsession with interest rates, it's sometimes easy to forget that a low interest rate won't reduce your mortgage by jack unless you plough those savings back into paying off your principal. Frances Cook outlines some ways to truly make the repayment period faster.

Buying a home is the biggest financial investment many New Zealand families will ever make. Which means, for those who can, paying off the mortgage early is a major step towards financial freedom.

In chasing that dream many will fixate on gettting a cheaper interest rate, but that’s not necessarily the key to mortgage freedom. Getting the best interest rate can help you have a cheaper mortgage (and a slightly nicer life) but if you don’t plough those savings back into your mortgage, you’re not making progress in that department.

When it comes to paying your mortgage off early, strategic financial coach Katie Wesney who works for Enable.Me, explains that extra payments are the key. This is because they go straight on to the principal, which is the amount you originally borrowed to buy the house.

By paying off extra there, you wipe off any interest and fees that part of the loan would have cost you, as if they never existed.

So an extra payment on the mortgage can be worth two or three times the money you’re actually paying, because of the saved interest. Only have an extra $20 a week? That could shave years off the repayment time. So how do you do it?

Most New Zealanders love a fixed rate mortgage, but it is the most difficult type of mortgage to pay off quickly.

It can vary between banks, so check the terms and conditions of your mortgage, but many will allow you to pay up to 5% extra without penalty.

Any more than that, and you usually have to wait until your fixed term is up, and then make a lump sum payment.

Funnel your extra payments into a dedicated savings account so that you’re ready when that time rolls around.

You can also arrange to pay your fixed term mortgage at a higher rate, when you refix it.

This still counts as an extra repayment, and gives you certainty, but the downside is that it can mean you’re locked into higher repayments even if you have a life change (like losing your job).

Revolving credit is a mortgage hack that’s a hot favourite amongst personal finance nerds, including Wesney. She says it’s the top way she recommends her clients clear their mortgage quickly. But while it works very well for some money personality types, it can be terrible for others

A revolving credit works a bit like an overdraft. You get a floating interest rate, which is slightly more expensive. But you can make extra payments at any time, giving you the freedom to make as many top ups as possible.

You can also get that money back out again, which is both the pro and the con of it.

It means that you can attack the mortgage, safe in the knowledge that if life happens, you can get the money back out.

It also means that if you’re someone who finds yourself tempted to dip into savings, you might go dipping into the revolving mortgage, and end up not making any progress at all. You’ll simply be paying a higher interest rate for no benefit.

If you’re someone who’s always been good with debt, paying it off each month, and never breaking into your savings account, a revolving mortgage can help you get ahead.

If that doesn’t sound like you… it may be best to stay away.

There are also floating mortgages which allow you to pay off more of the mortgage, but not take the money back out if you change your mind.

Then there are offset accounts, which have some similarities to a revolving loan but act more like a savings account. An offset account is typically an adjunct to your home loan. You can put money in there, and it “offsets” the interest in your mortgage, meaning that you don’t pay interest on the amount that’s in your savings. It’s as if you paid that amount off, while still having access to your savings.

A bank, mortgage broker, or financial adviser can help you investigate these options.

The key is remembering that they’re there, that the standard 30-year mortgage doesn’t have to be the default option, and that even a small extra mortgage payment could set you free years earlier.

You can learn more about mortgages and all things financial on Frances Cook's Making Cents podcast.

*This information is general in nature, and not personalised financial advice.