Planning your mortgage pays off
What if you could pay off your mortgage in 15 years? It’s easier than you think. However, most people won’t achieve it because they fail to set goals or take action. Most of us end up working for our mortgage. We get caught between juggling our debt and buying stuff that will break or be out of date in 12 months’ time. Everyone wants to be debt-free, it is the timeframe that makes it so daunting!
Facing your financial vices
Let’s face it - the easiest your mortgage will ever look is just before you buy. Once you move in with your mortgage, reality sets in fast. The budget you half-heartedly did (as you contemplated paint colours) begins to look extremely optimistic! Banks want you to repay your mortgage, but they don’t care about your morning latte or needing Sky Sport piped into the bedroom. It would be wrong to think your banker can make these trade-offs for you, or that they can figure out how much you can really afford. Getting realistic and fronting up to your financial vices is something you need to do for yourself. Creating a budget can feel laborious. A simple short-cut is to look at your rent and savings as a proxy. For example, $500 per week in rent and $1,000 per month in savings is equivalent to the repayments on a mortgage of $430,000 at an interest rate of 7.50%. When you apply for finance the process is backward-looking. The focus is on demonstrating that you can pay the mortgage. Looking backward, however, avoids the traps that can lie ahead.
Babies: the big budget speed bump
For first home buyers in their late twenties the obvious speed bump is starting a family. Starting a family at the same time as juggling a mortgage will most likely be your biggest financial challenge ever, followed closely by taking your partner out (financially, not for dinner) after a messy divorce. However, if you plan ahead, starting a family can be incorporated into your mortgage planning. At Squirrel we do that by looking at how quickly we can reduce the mortgage to a point where you can afford it on one income. Alternatively, we help you build a savings buffer you can use to cover maternity leave. We've found that on average our clients need $18,000 of savings to cover 12 months of maternity leave. If you can plan that into your mortgage from the start then it becomes easy. The other option would be to only borrow what you can afford on one income, but how realistic is that? In Auckland the borrowing power of one income will get you a garage in Grey Lynn or into a "socially challenging" part of town.
A bit extra really adds up
No matter what your circumstances, or what you’re planning on doing, the mortgage is always the elephant in the room. One simple rule that will get you ahead is to pay a bit extra, even if that is only $50 per week. On a $400,000 mortgage paying an extra $50 per week will knock four years off your mortgage and save you $79,000 in interest. Even better, you can hammer your mortgage by feeding it half of any future salary increases. Wage inflation is typically running at about 3% and your income tends to increase faster than this with age and experience. This approach is painless because you haven't had a chance to spend it yet! If every year you give up 50% of any wage increase to the mortgage you will take eight years off your mortgage. So almost all homeowners can pay off their mortgage in less than 15 years, it just requires a bit of planning and action.