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Retirement savings - middle years

The timeline of events that define the second life-stage – career, house, and children – is more flexible these days. But whatever path you're following, one question stays the same: to buy or not to buy a property?

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Property ownership defines your financial landscape. And when it’s combined with the demands of family and career, owning your own home can make it difficult to meet your financial goals. Yet for many Kiwis it's worth the investment.

If you decide to become a property owner … how can you manage your costs without too much angst? … what kind of mortgage should you choose? … and how do you balance paying off mortgage debt with saving?

Home ownership and savings

There's been vigorous debate over Kiwi home ownership and its impact on savings. Most people's assets are concentrated in their homes, which can leave them vulnerable to a fall in house prices. Newer homeowners have high proportions of mortgage debt because of rising house prices, which can make it extremely difficult to save more than the mortgage payments. The risk is that many homeowners will have a serious savings shortfall at retirement.

But others argue these fears are overstated. Paying a mortgage can be described as "passive saving", especially if the value of your home is rising. As well, a public-policy working paper by Motu, a research group, concluded that people with higher "passive" saving also tended to have higher total saving.

The Commission for Financial Literacy and Retirement Income says that those who own their homes mortgage-free are much better off in retirement. Its research has found that among people aged 65 and over, only 3 percent of those who own homes without a mortgage are in low-income households, compared with 20 percent of those still with a mortgage and 47 percent for renters.

Mortgages

Most people who buy a house will need a mortgage. (Fun fact: "mortgage" comes from Old French and means “dead pledge".) Reserve Bank figures show many of us are willing to make this commitment: 25,744 new housing-loan approvals were made in December 2012.

Make sure you shop around before you settle on a mortgage provider. Don't automatically choose your usual bank: you can often get a better deal elsewhere … or you can use other banks' rates as a basis for negotiation.

It's a good time for getting a good deal: low mortgage rates combined with increasing housing-market activity has resulted in fierce competition between banks. Requirements for the ratio of your deposit to the amount you need to borrow have begun to relax for the first time since 2009. Banks are also offering benefits to sweeten the deal, such as dropping fees or negotiating rates.

Mortgage types

Most people have a conventional table mortgage, in which your payments are the same over the “life” of the mortgage. At the beginning you pay mostly interest; by the end it's mostly principal. But there are other kinds of mortgages which may suit you better – and some of these can be combined with a conventional table mortgage.

Revolving credit: This acts like a large overdraft that’s secured by the mortgage over your home. Interest applies when you're overdrawn, and you can be overdrawn up to the full mortgage amount.

  • Pros: Flexible. Allows lump-sum payments.
  • Cons: Requires discipline to make sure you pay down the balance. Is often combined with a table mortgage to make sure some of the mortgage is being paid off.

Offset: You can use your savings to cut down the amount of interest you pay and the length of time your mortgage runs – the more you have in your savings account, the less you pay on your mortgage.

  • Pros: Flexible. Can reduce the amount you pay on your mortgage. Allows lump-sum payments. You can get at your savings if necessary.
  • Cons: Discipline needed. If you spend from your savings, your interest goes up. Can be combined with a table mortgage to make sure you’re paying off some of the mortgage.

Reducing: You pay the same amount of principal with each repayment. This means your interest also reduces with each payment, so your repayments decrease each time.

  • Pros: Can help you pay down your mortgage relatively quickly and lightens payments later in the mortgage. Allows lump-sum payments.
  • Cons: Can be financially painful at the beginning – because you’re paying interest and principal with each payment.

Interest-only: These are usually short-term mortgages: you pay off none of the principal.

  • Pros: Payments are more manageable.
  • Cons: Doesn't build equity in your home. Makes you vulnerable to falling property prices – and you'll have to pay the principal sometime. You can do this either all at once at the end of the loan, or you can opt to take out a table mortgage once your term is up.

Fix or float?

To float or fix is endlessly discussed. Mortgage interest rates are currently low: Reserve Bank data show that average floating rates are 5.87 percent and they’re tipped to stay that way for some time. But you can get a fixed rate that’s even lower and so there's been a flight back to fixed-term mortgages.

However, (to reverse the usual wisdom) everything that goes down must come up. And they do come up – between December 2004 and December 2007 average floating rates rose from 8.51 to 10.29 percent. The moral: you can keep an eye on economic forecasts but the decision on fixing vs floating is always a gamble. One option is to have part of the loan fixed and part of it floating, to give you some protection against sudden changes in interest rates.

While low rates can tempt you to more expensive properties, be careful not to over-commit. Set your budget so that you'll be able to keep up your payments if rates increase. An even better way for making the most of low rates is to take on higher payments and make inroads into your principal. But make sure that your bank won't penalise you if you want to decrease your payments later. Or look for a mortgage that allows you to vary payment amounts.

Check out our case study "Hannah and Grant", below, to see how they budget to pay a mortgage with 2 children and 1 income.

Property as an investment

Sometimes buying property is a purely financial decision. And with seemingly constant media reports about booming prices, it's easy to understand the appeal. People always need somewhere to live – and if property values do nothing but increase, this investment seems “as safe as houses”. Add the fact Kiwis don't pay capital gains tax on long-held properties that haven't been bought solely to sell at a profit and it appears a no-brainer.

However, it’s not that simple. It's true Auckland and Christchurch property prices are buoyant because of high demand and low supply. But the picture is different in smaller towns and rural areas, especially in those depending on a single industry for employment. Property values have steadily declined since the boom market of 2007 and rental vacancy rates are high.

David Whitburn, a property investment consultant, advises you take these factors into account. He also advocates being financially conservative: "I'm not a fan of negative gearing [when people have higher outgoings than income]. I've seen too many people stung because of it. It's best to keep a positive cash flow so that if the worst happens you don't have to sell – maybe at a bad price – and lose your money. You should also make sure you have insurance to cover your rental property."

If you already have some equity in a property, you can use this as leverage and secure it over an investment property. This is the way most small investors enter the market. However, it then becomes even more important to maintain a positive cash flow – because if you run into trouble with your mortgage payments you can lose both properties. You also need to plan for other expenses beyond the mortgage. See our case study "Liam", below, to see how this kind of investment can work.

Case study: Liam

Liam is 34. He’s done well in his career as an electrician and has a much higher income than he had in his twenties. He owned his own home in Auckland’s Waitakere for 2 years before he bought his rental property. His home-mortgage payments come to $360 a week but he splits this with 2 room-mates and so only pays a third.

For his renter he chose an apartment close to the central city in Newmarket, which offered an affordable way to enter the Auckland rental market. He decided to invest in rental property rather than shares and bonds. He used the equity he already had in his first property as security. The apartment cost him $234,000 and he added another $10,000 to the mortgage to pay for painting and small renovations before renting it out. (He did these himself to save money.)

Liam’s worked out a budget which includes his property costs (rates, insurance, property maintenance and body-corporate fees, plus an allowance for four weeks a year of vacancy). He's included his personal “living costs” such as utility bills, transport, clothes and entertainment. His budget shows there's not much money in his pocket at the end of the week. If he cut back on his living costs he could have more.

Liam's weekly budget $
Income
Gross salary income 1346
Rent 350
Outgoings
Tax & ACC levy 295
Mortgage (home) 120
Mortgage (investment) 340
Allowance for vacancy 29
Body-corporate fee 50
Rates 63
Insurance 68
Groceries & food 120
Utilities & transport 210
Clothes & entertainment 220
Savings
Retirement 135
What's left 46

Case study: Hannah and Grant

Hannah and Grant are 33 and own a 3-bedroom "starter" house in Nelson they bought for $295,000 with a 15 percent deposit. They did this 2 years before they had their first child, working hard at paying down the mortgage on a fixed rate of 5.25 percent.

When their first child was born, they went down to one income as Hannah left work to care for him. They refinanced their mortgage at a 1-year fixed term of 5.45 percent.

To make sure they’ve enough money to meet expenses on their lowered income, they have a detailed budget that spreads out their costs over a year. This way they can plan for every expense, from weekly expenditures like food to less frequent ones like dental appointments. Over time they’ve refined their budget and made adjustments where necessary. They manage to keep down costs by shopping at the local vege market and buying second-hand.

Living in Nelson gave them access to a lower-priced house than they would have bought in a larger city. Because of this, they’ve been able to continue making payments into Grant’s work retirement scheme at 5 percent of his income. They’ve also continued to make payments into Hannah’s KiwiSaver account at the rate of $1200 per year. The government pays 50 cents for every dollar of a member contribution up to a maximum of $521.43 (this requires a payment of $1042.86), so their payments ensure Hannah receives this tax credit and keeps her savings growing while she's out of the workforce.

Hannah and Grant would also like to save money for their children's tertiary education. One option they could consider is for Grant to take out an endowment policy. This is a type of "term" life insurance for a set period which also functions as a saving plan. You pay in regularly and decide the date on which you want the policy to mature and pay out the endowment. If you die before it matures, the policy is paid out and your child receives the endowment. However, only Tower and AMP currently offer them.

The other option is a locked-in savings account which is designed to encourage saving: if you make a withdrawal, your interest rate significantly decreases. They will only work if you make regular deposits and don't touch the money until you have reached your savings goal.

Because Hannah and Grant have only 1 income, it's probably more important to make sure they're covered in case something happens to that income. The Commission for Financial Literacy and Retirement Income’s website (sorted.org.nz) advises people to have 2-3 months' salary saved as a back-up against unforeseen events such as accidents, ill-health or redundancy. Hannah and Grant could save what's left over from their weekly budget into a savings account, or they could consider mortgage-protection insurance.

Alternatively they could invest the money.

Hannah & Grant's weekly budget $
Income
Gross income 1442
Outgoings
Tax & ACC levy 319
Mortgage 325
Rates 30
Property maintenance 40
Insurance 44
Groceries & food 210
Utilities & transport 176
Playcentre 5
Health 25
Clothing & entertainment 120
Savings
Retirement 95
What's left 53

Report by Amanda Lyons.

The cost of a child

It's generally accepted that it's expensive to raise a child. But how much does it actually cost?

A 2009 study commissioned by the IRD put the average cost of raising a child at $265,824. That's $13,936 per year from birth to the age of 12 and $16,432 per year from 12 to 18.

The study also found spending on children was not equal across all households. The amount and proportion of income spent increased with the family’s level of income: high-income households spent more than twice as much on their children than low-income households.

The study didn’t include other expenses associated with raising children – such as life insurance, loss of income, or having to buy a larger house because you have children.

Budgeting help

The New Zealand Federation of Budgeting Services has branches nationwide and budget advisers who can give you face-to-face help. Their services are free.

If you prefer to do it yourself, we've found some helpful sites.

These are either free or can be joined at a low cost. We were impressed with their services when we looked at them in 2009. They also didn’t require your online banking logins and passwords. Providing these details to a budgeting site would break the terms of your contract with your bank and you would have no comeback if you’re later a victim of online banking fraud.

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