Money

Reducing mortgage risk

Updated: 07 May 2008
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Introduction

Interest rates remain high as property prices begin to fall. We give you our tips on managing your mortgage in risky times.

After several years of cheap free-flowing mortgage finance, the party's over. Interest rates have increased dramatically and mortgaged homeowners will be feeling the pain for some time to come.

So what can you do? Here are our tips and strategies on how to reduce your mortgage risk.

Plus, for more information, calculators and case studies see our mortgage guide and mortgage strategies reports.

Higher-interest risk

According to the Reserve Bank, the average mortgage rate being paid on outstanding mortgage debt is now at its highest level since October 1998. Almost 90 percent of all mortgages are on fixed rates with nearly a third of these due to be renegotiated over the next 12 months: for each $100,000 they owe, these borrowers could face increases of between $700 and $1500 a year ($58 to $125 a month).

Plan ahead as soon as possible if you think your payments are going to go up:

  • Maybe you can afford the increase - with or without changes to your lifestyle.

  • Do you need to cut back on some items in your budget to make up for the higher mortgage payments? Work out what bills should be top priority for payment - such as rates, power, telephone, other debt. Then look to see where you can make savings. (Always make sure you pay your rates. Local authorities can approach your mortgage lender for payment if their borrowers are behind with their rates. They also have the ability to give extra time or concessions on rates payments in times of hardship.)

  • With a fixed-interest-rate loan there'll usually be plenty of advance warning about increases in your interest payments. And if you've significantly reduced the amount of the loan - your principal - since the interest rate was last fixed, your interest payments will be lower than they'd otherwise be.

  • See your lender as soon as possible if you think there's any danger that you'll miss a payment. It'll be much easier to reach a reasonable agreement with your lender if you co-operate early. Don't wait until legal action is threatened.


What's driving higher rates?

Defaults on high-risk (sub-prime) loans in the US have caused international lenders to become cautious and this has raised the costs of overseas borrowing for New Zealand banks. As well, the Reserve bank's official cash rate - which sets the benchmark for local interest rates - is high. And there are also fewer lenders than there were, because the credit crunch has cut off sources of finance for non-bank lenders.

All these events are keeping interest rates up and reducing the amount of money available for borrowing.

Dealing with your lender

A lego house

Before your fixed rate expires, shop around. Lenders will often offer discounts on their advertised rates to win business or to keep a good customer. If you receive a good offer from another lender, your existing lender may match it. Make sure you consider any extra fees and charges in switching.

Can't do the shopping around yourself? Consider using a mortgage broker to do it for you. Members of the New Zealand Mortgage Brokers Association follow a code of ethics. Brokers are paid in commission from the loans they arrange, although some may charge the borrower a fee in complex cases.

If possible, reduce your borrowing. Look at selling some assets or using savings to pay off mortgage debt. Repaying debt gives you one of the highest risk-free returns available because of the interest you save - but check whether there are any early-repayment penalties on your loan. A revolving line of credit (RLOC) mortgage, where you can pay off debt quickly but can also borrow quickly if necessary, may be worth considering. But be aware that RLOCs have a downside - see Mortgage strategies.

Look at extending the term of your loan. This will reduce your monthly payments. But it also means you'll end up paying more interest in the long term - unless you pay off lump sums or reduce the term of the loan at some later date.

You can reduce your overall payments by switching to interest-only payments (for part of the loan or all of it).This is only a short-term fix, though. When you're no longer paying off principal, your loan's not getting any smaller - which makes you vulnerable to future interest-rate rises. Aim to resume principal payments in the future.

Some lenders allow you to temporarily reduce your mortgage payments or take a break from payments. But you will continue to be charged interest and this may be added to the loan. Sort out with your lender how you'll make up the missed payments.

Credit-cards and personal-loan debt is usually more expensive than the interest on your mortgage. So look at reducing your overall loan repayments: consolidate other debts and add them to your mortgage. But take care not to increase your borrowings after you do this.

Mortgage strategies

A house money box

Mortgage rates could remain high into 2009 - and there's no consensus from the economic experts about when they'll fall. So there are several possible ways of re-arranging your mortgage.

Borrowers tend to chase the lowest fixed rates available. For those who need certainty and are on a tight budget this can be the best strategy.

But there are cheaper options: in 2007 we looked at five mortgage strategies.

  • The cheapest was to use a revolving line of credit (RLOC) together with a series of two-year fixed-rate mortgages. The trick here was to pay off debt steadily with the RLOC (into which all salary and income was paid). This strategy also assumed that the borrowers paid for most of their everyday expenses with a credit card and made maximum use of their card's interest-free period.

  • Another strategy is to opt for a fixed rate of six months or a year, in the hope that interest rates will fall quickly at the end of that period.

  • Or you could go mainly for two-year fixed terms, with possibly part of the mortgage on a five-year term in case rates don't fall fast or far enough. Getting a reasonable five-year rate may be tricky: some non-bank lenders were charging well over 10 per cent and closer to 11 per cent for a 5-year fixed term, although the major banks were charging less when we went to print.

  • Borrowers with larger mortgages could consider fixing their mortgage over a range of time periods, so that only a certain amount has to be re-borrowed at a possibly higher rate each year.


Revolving credit loans

We recently asked readers for their experiences in using revolving line of credit (RLOC) mortgages. Most of those who wrote to us were happy with their RLOCs, but several said that they needed to budget carefully to make the most of them. One reader swapped a RLOC for a fixed rate because it had been too difficult to keep the debt down once the interest rate started to rise: "budgeting was a nightmare".

Another reader said: "We got a $100k line of credit four years ago to cover most of our mortgage. Initially it was fine and we only withdrew funds once, but in the past six months we've really struggled with it. Our mortgage should have been paid off by now - but we've redrawn significant amounts to 'pay down' our credit card, then seen the credit card pop right back up again. We still like the line of credit and are glad to have it, but it takes a new level of discipline to manage it responsibly."

Steve Southall

Steve Southall (pictured) from Birkenhead told us: "I took out a combined RLOC and fixed mortgage on a property I purchased a year ago. As a contractor my income is intermittent, so the RLOC account gives me a lot of flexibility.

The temptation is to spend, but with a bit of self-discipline a RLOC account is an excellent tool for managing my finances and certainly better than incurring interest on my Visa card."

Jack and Irene Burden of Taupo have had a RLOC for three years and said that it was an "absolute boon" when they needed bridging finance for about five months. It was much cheaper than a conventional bridging loan. The Burdens have dipped into their loan since (during a period of illness in the family) but they're now mortgage free. They'll keep their RLOC, though: it's "an excellent standby for quick money ... but we don't take any money out unless we know there is some coming in to cover it."

The message seems to be that RLOCs are flexible and can save you money on your mortgage - provided you have the financial discipline for the long haul.

Property investors' risk

Many investors have been subsidising mortgages on investment properties from their income in the belief that capital growth would make up for this in the long term. This has become increasingly expensive.

If interest-rate rises are starting to hurt, work through your options:

  • Raising rents is a possibility, particularly if you haven't done so for some time. Make sure you claim all allowable tax deductions on your rental properties.

  • Selling a property, if you have more than one, will help clear some of your debt. It's probably better to protect the family home (which may have provided the equity for buying your investment properties) than hang on to the rental properties too long.

  • Organise your debts so that borrowing is spread across a range of fixed-rate terms.

  • Avoid panic borrowing - it may be tempting to try to reduce costs by extending the term of your mortgages or asking the lender to reduce payments but the reality is you're over-extended and need to sell a property.


If your lender stops taking on new loans or sells its loan book to another company, business may go on as usual. But a lender that's closing down its business may take a tougher approach if you get behind with your loan payments or ask for a change to your loan.

Other risks

Negative-equity

If your loan is bigger than the value of the property it's secured against, this is called negative equity.

Negative equity isn't necessarily a problem. But it will be if you want to sell or can't afford the repayments. What's more, Auckland property lawyer Jonathan Flaws says that some mortgage agreements give lenders the right to ask for a revaluation - and to require part of the loan be repaid or additional security be put up if you're shown to have negative equity.

He also says that with negative equity you'll need the permission of the lender to sell, and it's advisable to work with your lender to get the best price for the property. That way it's less likely you'll be pursued for any outstanding debt or have a bad-debt judgment made against you.

Risks for parents

Parents are increasingly helping their children on to the housing ladder, but there are risks in this.

Banking Ombudsman Liz Brown says that it's becoming more common for banks to suggest that parents become joint borrowers with their daughter or son (rather than simply guaranteeing their offspring's loan). But if loan payments fall behind, both borrowers become liable.

Liz Brown also points out that when a bank is lending to joint borrowers and knows that one of them won't benefit from the loan, it must advise that borrower to get independent legal advice.

Parents should also get legal advice before they offer one of their children financial assistance to buy a property. They shouldn't consult the solicitor who is representing the children. The parents' future financial needs to be considered, as well as those of other children.

Asking for help

The New Zealand Bankers' Association (NZBA) Code of Banking Practice says: "You should contact us before you default under any credit facility or as soon as possible thereafter as the sooner you contact us, the better position we will be in to assist you."

ANZ, ASB, Bank of New Zealand, Citibank, HSBC, Kiwibank, National Bank, TSB, and Westpac are members of the NZBA. Not all lenders are, though.

Borrowers may also have rights under the Credit Contracts and Consumer Finance Act. You can to ask for a review of your case if it's a result of unforeseen hardship - but you must apply before defaulting.


More information

More from consumer.org.nz


Report by Maria Scott