Should You Make Extra Mortgage Payments?

The pros and cons of making extra mortgage repayments

Getting on the property ladder is a great feeling, though once you’re there you might soon realise that’s only one step of your financial journey. The next big goal often then becomes repaying your home mortgage, and with usual mortgage timeframes of 30 years it is a lot tougher for most people than buying a home in the first place!  

This begs the question, should you make extra mortgage repayments to pay down the loan – and be mortgage free – a lot faster than the standard 30-year loan term? Just like most things when it comes to personal finance, there are pros and cons here, so let’s explore both sides of the argument for and against making extra loan repayments.  

Benefits of Early Mortgage Repayment

Paying off your mortgage early can have numerous benefits. Some are obvious, some are not so much.

Save on Mortgage Interest

Housing is nearly always one of the biggest household expenses.

By repaying a mortgage early, you can save a lot of money on interest payments. This is the most substantial financial benefit. Over the life of a mortgage, a large portion of your repayments goes towards interest. By making extra payments, you reduce the principal balance faster, leading to less interest accruing over time. This can save you tens of thousands of dollars in the long run. For example, even a small increase in your regular payments or a few lump-sum payments can dramatically shorten your loan term and reduce the total interest paid.

By making extra payments towards your mortgage, you’ll reduce the amount of interest you pay over the life of the loan. This equates to more money in your pocket over the long-term.

An added benefit here is you’ll be less at the whim of potential future increases in interest rates, as the higher rates will apply to a smaller loan amount, or to no loan at all.

You Build Equity in Your Home Faster

Early repayment accelerates the rate at which you build equity in your home. Equity is the difference between your home's value and the amount you still owe on the mortgage.

Building more equity can free up money for other financial goals, such as retirement savings, the capacity to take a year to explore the world, or something else.

Increased Financial Flexibility

Once your mortgage is paid off, a significant portion of your monthly expenses disappears. This frees up a substantial amount of cash flow that can be used for other financial goals, such as saving for retirement, investing, starting or buying a business, paying off other debts, taking extended time off work (perhaps to travel or raise a family), or simply to enjoy more discretionary income.

Potential Higher Returns

The money you would have spent on mortgage payments can now be directed towards investments that may offer a higher rate of return than the interest rate you were paying on your mortgage.

Eliminating a large debt like a mortgage can give you a greater sense of control over your financial future and empower you to make choices aligned with your long-term goals.

Peace of Mind Knowing You’re Mortgage Free

For many, this might be the biggest benefit! There’s something freeing knowing that you own a little slice of New Zealand, free and clear from any bank or mortgage lender. This sense of satisfaction can give rise to an increased sense of relief, calm and peace, knowing that whatever happens financially at least your housing costs will be minimal.

However, even when you’re mortgage free, you still face a few housing expenses which will probably never go away. Of course you’ll not have to make mortgage repayments, but remember you’ll still need to fund:

• House insurance: Protecting what is probably your most valuable asset against unforeseen events is crucial, even without a mortgage.
• Council rates: called property taxes in most parts of the world.
• Water and wastewater charges: especially in larger New Zealand cities, you'll receive separate bills for water usage and wastewater (sewage) services.
• Contents insurance: While house insurance covers the physical structure of your home, contents insurance protects your belongings inside, such as furniture, electronics, clothing, and personal items.
• Home maintenance: homeownership comes with ongoing maintenance responsibilities.
• Rubbish and recycling collection: While often included in council rates, some areas might have separate charges for additional rubbish collection services or specific types of waste disposal.
• Body corporate fees, if applicable: If your property is part of a unit title development (such as an apartment or townhouse complex), you'll likely have to pay body corporate fees. These cover the maintenance and insurance of the common areas (for instance, shared driveways, gardens, building exteriors), as well as administrative costs. Body corporate fees can vary significantly depending on the complex and the services included.
• Potential future capital expenses: While not routine in the same way as monthly or annual bills, think ahead and save for larger, less frequent expenses like roof replacements, driveway repairs, or major renovations.

Learn more:

• ‍How to pay off your mortgage early
• Why you need more debt in your life
• Should you borrow to invest?

Drawbacks of Early Mortgage Repayment

There are a few benefits to not making extra mortgage payments, and redirecting those funds elsewhere. At first this might sound like crazy talk, (who wouldn’t want to be mortgage-free sooner, right?) though try approaching this topic with an open mind.

1. Repay Higher Interest Debt Such as Credit Cards

Many Kiwis are still having a hard time with credit card debt, vehicle loan repayments, and other consumer debts such as store cards and the modern buy now pay later schemes such as Afterpay or Laybuy.

If this is the case, the interest rates can be ten times higher than the standard mortgage interest rates, so it makes sense to tackle these ‘bad’ debts first. Only then, reconsider whether making extra mortgage payments is right for you.

2. Build a Rainy-Day Fund

It’s smart to save enough accessible cash for the contingencies we all occasionally face. That might include a job loss, car repairs, major whiteware replacement, emergency travel to see a loved one overseas, or nearly anything else that pops up unexpectedly.

Many financial gurus suggest a cash stash of three-to-six months’ worth of living expenses to meet life’s eventualities, though – as with anything – what any individual or family needs depends on them.

Without such financial reserves in place, anyone with a mortgage could put themselves at risk of not being able to make their repayments should something unexpected occur.

3. Build A Cash Stockpile for Something Good

This can be broadly broken down into two categories:

i. A Deserved Reward

If you are able to, perhaps it’s time to take that overdue holiday to Europe or America? Or perhaps to save and spend on a major item, or major experience you’ve thought of but not got around to? Maybe buy a holiday home, or a big item such as a boat.

It doesn’t make much sense to go into credit card debt or fund such a trip with additional mortgage lending. Saving up for it will probably make the reward that much better too!

ii. To Make a Big Move

Aside from an emergency ‘rainy-day’ fund of some kind, there could be other reasons to build up cash:

• To fund a training course or qualification so you can earn more, or
• Some investments have minimum thresholds or might not make much sense with a small sum. This might include subdividing a property or another significant activity, or
• To buy in to a business or other venture, perhaps with a close friend or family member, or
• To start a business or side-hustle of your own.

Beware. Despite what is mentioned above, saving money as a long-term wealth building strategy is unlikely to work. Unless there is a specific short-term need, nowadays it is usually unwise to save money over the long-haul in bank accounts and term deposits.

‍Learn more: Don’t save money

4. Invest In Investment Markets Instead

Want to turbocharge your wealth? The argument for investing instead of early mortgage repayment hinges on the idea that long-term market returns should outpace your mortgage interest, making your money work harder in the market than by simply reducing debt. Think potential for bigger gains over time!

However, don't jump ship on early repayments just yet! Investing comes with risk and volatility, while every extra mortgage payment offers a guaranteed "return" equal to the interest you save.

Ultimately, there's no one-size-fits-all answer. The smart move blends your financial goals, risk appetite, and the current economic landscape. Maybe a bit of both – chipping away at the mortgage while investing is your winning formula. Consider your options wisely and make your money moves count!

The difference between the mortgage interest rate and the investment return is where the long-term opportunity might be.

Diversification and Flexibility

Aside from just a pure “interest rate versus investment return” calculation, there are probably other benefits to this too.

For example, there are an array of highly diversified non-KiwiSaver investments available, commonly called managed funds. Most come with low fees, the ability to access your money at any time, and no contribution or withdrawal costs, so these sorts of funds might be a good choice instead of extra mortgage payments, as the benefits on offer could include:

• Start to diversify wealth away from just a home and KiwiSaver, and
• Offer greater flexibility than just paying down a mortgage. The invested funds can usually be accessed at any time without charge or penalty. This compares a lot better than running to the bank ‘cap in hand’ to try and get extra lending to spend on something such as a year off-work travelling, to fund a renovation, children’s education, or for any other reason.

5. Refinance or Restructure Your Mortgage

Instead of making extra mortgage payments, there are several choices here which could work well if used in conjunction with the other points on this list:

• Refinance. Refinancing is the process of switching a mortgage from one bank to another and renegotiating the terms of the loan. In most cases, the idea is to get a better overall deal, as banks will often entice new business off competitors and offer great rates and even cash incentives.
• Refix. When any fixed rate mortgage is coming to the end of the fixed rate term, the bank will offer a new rate. The end of the fixed term is your opportunity to review your needs, as well as personal and financial circumstances.
• Restructure. While the mortgage interest rate is important, it’s not the only thing to consider. Mortgage restructuring is the process of rearranging a home loan into a winning combination of fixed and perhaps floating interest rates, setting the right term or terms for fixed portions of the loan, and ensuring appropriate loan repayment amounts are set. You could use your surplus income to whatever you please, including other things explained on this webpage.

In many cases, stiff competition between the big banks means that many people can drop their mortgage repayment to increase their regular surplus while still paying off the mortgage in the same timeframe (so the increased regular surplus could be used for a good reason elsewhere), or keep their mortgage repayment the same and still repay it years earlier, or another arrangement to suit them and their situation.

Talk with our lending team to see if this might make sense for your situation.

The Bottom Line – Should You Make Extra Mortgage Payments?

So, what is the key to solving the extra mortgage payment puzzle? There's no magic bullet.

The pursuit of possibly higher investment returns and more flexibility is tempting, but the guaranteed win of slashing debt and stress is also powerful. Your call hinges on your appetite for risk, financial goals, and starting situation. Weigh the options wisely and choose the path that lets you sleep most soundly at night.

It would be the pleasure of our team to have a chat about which option or combination might best suit your unique situation. This includes if you’d like to explore investing away from your existing home or refinancing or restructuring your mortgage debt.