Paying off the mortgage is the number one goal for many Australian property owners. For most of us, our mortgage is the biggest debt we will ever have in our lives, and dictates how we run our finances. Over 76% of Australian’s recognize that mortgage stress has a significant impact on their lifestyle, and paying off the mortgage would remove a significant financial burden and improve their quality of life.
So is it practical to pay off your mortgage early, what are some of the common strategies used, and what actually happens when you pay off your mortgage in Australia?
Should I get a mortgage in Australia?
There are many strategies you can take when it comes to having a mortgage in Australia – But they really boil down to two major choices;
- Owner occupier ‘traditional’ home loan, or;
- Investment property loan
Depending on whether you are seeking a mortgage for a personal home to live in, or a loan for an investment property will massively influence how you treat the mortgage and whether you would ever want to pay it off or not. Generally speaking, a personal home loan mortgage is not tax deductible, whereas the interest on an investment property mortgage is tax deductible.
The main point of an investment property is to make you money, or grow the investment over time. This can be done through Positive gearing where the investment property makes a positive cash-flow each month which puts money into your pocket, or through Negative gearing where the investment property makes a negative cash-flow or a loss each month which you pay out of your income (the hope being that the property goes up in capital value over time and this exceeds the money your losing in the short term after tax benefits).
In both cases though, a mortgage is considered a hedge against inflation in modern fiat currency banking systems. This is because you are borrowing today’s dollars, using them to control an asset, and then paying them back with tomorrow’s dollars. Over time we know our currency inflates and this is linked to government monetary policy (such as the RBA interest rate) – over time, inflation weakens the dollar and erodes its purchasing ability.
Now lenders aren’t silly, and so they make sure that when they lend out money, they apply a nice juicy buffer between the official RBA cash interest rate and what they charge their customers – to make sure they aren’t losing out in the long term. Of course, banks aren’t really lending out THEIR own money anyway – thanks to fractional lending mechanics and lending laws, they can actually create currency out of thin air – called credit – and charge interest on it. This is how their business model works. Most banks have to contain a certain amount of ‘Vault cash’ (usually 10% of total deposits) in case some people want cash. However increasingly our society is going more and more cashless (which benefits the financial and information industries) and industries poised to profit from this lobby for government support and increased anti-cash legislation in the guise of anti-criminal, terrorism and money laundering efforts.
Whether or not this system is sustainable in the long term aside, right now interest rates are at historic lows and borrowing has never been so cheap. This means having a mortgage is very affordable and it has been encouraging people to overstretch on a mortgage – maxing out their serviceability. This over supply of ‘cheap cash’, coupled with lax foreign investment standards, has driven property bubbles in some parts of Australia to record highs. For example, capital cities like Sydney and Melbourne are experiencing extreme housing affordability issues where average property prices are well over $1M, compared to the national median wage of $48,360 (before tax) according to the ABC and national average wage of $89,128. according to the ABS. Houses have never nominally been so expensive in terms of the ratio of housing price to median income. Of course, it is worth mentioning that the average salary of inner city Sydney and Melbourne workers is much higher than the national average, and many savvy investors living there for work choose to rent and invest elsewhere.
This leads to the question, if there is a bubble – when does the party end? Well. It is certainly not in the interests of the status-quo. Banks, lenders, developers, politicians, wealthy individuals and older Australians are all heavily invested and tied to the property market. Actually, property is Australia’s biggest industry, and second biggest employer – worth over $182 billion annually, and making up over 11% of our national Gross Domestic Product. It is not just the wealthy who this affects though, and 1 in 4 Australian’s rely on wages paid through the property industry somehow – Architects, Designers, Builders, Tradespeople, Bankers, mortgage brokers and Property Maintenance, just to name a few. If that isn’t enough, over 14 Million of us are invested in property either directly or through our Superannuation funds.
So is getting a mortgage a good idea? It’s up to you. If you aren’t sure, maybe pay a good independent financial advisor to assess your personal circumstances. Whilst it might sound a little scary, I am personally taking advantage of record low interest rates, but I am not choosing to invest in inflated markets like inner city Melbourne or Sydney. I have chosen to invest in ‘cooler markets’ in more regional areas which I think represent better value for money, and are more cash flow positive. I am not over stretching myself – a mortgage well under my serviceability cap (about 25%), an LVR of about 65%, and a total ‘loan value’ of about a third of my total net worth.
It certainly will be interesting times ahead, but I am happy to take the gamble on a small leveraged position on an investment property to enjoy cheap credit with an interest only loan. I do not think that our policy and decision makers will allow the Australian property ‘religion’ to die, and I recently read about more restrictive lending reforms and legislation being reversed due to COVID-19 in an attempt to continue to stimulate the market. The party rages onward!
Why you should pay off your mortgage
- Peace of mind and less stress – you will always have a place to live
- Satisfaction / Pride of owning your own home outright
- No more interest payments
- Better than saving money in a bank account – effectively you are getting a higher interest rate, which is also tax free further ‘grossing up’ the yield.
“If you have available cash, an effective use of the funds is to pay extra on your mortgage. This not only saves you paying interest at a higher rate than the interest you would earn on your cash in a savings account, but it also means you are not paying tax on any interest earned.”YourMortgage.com
- Lower cost of living
- Simplified finances
- The mortgage doesn’t influence your financial decision making anymore
- Your level of risk tolerance on investment properties may have changed
- Put your wealth in your Primary Place of Residence so you can access social security payments (which often don’t means test against a PPOR)
- Simplify estate planning in the event of your death
- If interest rates go up you might not be able to afford the repayments.
- Remove ongoing annual mortgage account keeping fees (which can range from as little as $500 up into the thousands)
- You have a significant emergency fund or other financial assets and don’t need the flexibility of a mortgage offset account
Why you shouldn’t pay off your mortgage
- Mortgage is considered a hedge against inflation and thus can be a long term net worth builder if used strategically.
- Allows you to control many investment properties by only putting down a small down-payment on each rather than outright buying
- Paying off the mortgage locks up significant amounts of capital in a non-liquid asset – hard to get access to this in an emergency or should your financial situation change.
- A home (Primary Place of Residency) does not produce anything – better to invest in things that make you money;
- You can invest that money in brokerage accounts instead and get higher returns on shares than you would save on any interest repayments
- You can invest that money into the tax effective environment of your superannuation and get higher returns
- You can invest that money into deposits for investment properties(s) with tax deductible mortgage interest and depreciation schedules.
- If you are into ‘Rent-vesting’, mortgage repayments could be cheaper than renting in some circumstances anyway (i.e. usually in rural areas)
- You can use ‘debt recycling’ to turn your non tax deductible PPOR Mortgage into a tax deductible form of interest
- Keep an interest only loan on an investment property to maximize cash flow and profit now rather than locking up principle repayments as equity.
- Benefit from the current record low current interest rates and ‘cheap loans’
- Might be significant early exit penalties on your specific loan.
- If you have a very stable, high income with appropriate levels of income protection insurance you would generally always be able to meet mortgage repayments
- Security and fraud protection – Having an active mortgage (even if it was only $1) with a lender against your property makes it incredibly unlikely that a fraudulent mortgage could ever be taken out against your property.
- Having a mortgage means you can keep your emergency fund in an offset account where it has increased effective yield and is easily accessible.
How do I pay off my mortgage faster
If you want to pay off your mortgage faster, There are a few things you can consider doing in order to knock it down quicker;
- Switching from Monthly to Fortnightly or Weekly repayments
“If you’re currently paying monthly, consider switching to fortnightly repayments. By paying half the monthly amount every two weeks you’ll make the equivalent of an extra month’s repayment each year (as each year has 26 fortnights).”ASIC’s MoneySmart
- Refinancing to reduce the agreed loan term (increasing repayments but also decreasing total interest payable)
- Refinancing to reduce the interest rate on the loan
- Making additional repayments
“Putting your tax refund or bonus into your mortgage could save you thousands in interest or can cut your loan by years. On a typical 25-year principal and interest mortgage, most of your payments during the first five to eight years go towards paying off interest. So anything extra you put in during that time will reduce the amount of interest you pay and shorten the life of your loan.”ASIC’s MoneySmart
- Opening and contributing into a mortgage offset account
Engaging with a mortgage broker to pay off your mortgage
Engaging with a mortgage broker might help you find a better lender for your situation. If you want to pay your loan off sooner, they could potentially help you refinance to a new lender with a reduced interest rate or with features like offset accounts which help reduce the total interest payable. This can let you focus your efforts on paying down the capital (or mortgage principle) faster and with greater flexibility.
Paying off your mortgage using your Superannuation
If you are past your preservation age, then withdrawing a tax-free lump sum from your Superannuation account is a great way to pay off your mortgage. This is the exact strategy my parents recently used to pay off their home loans. This strategy is especially powerful for those with not much in their super, because it can lower your total balance below the asset test for social security payments through Center-link like the Job-seeker payment. From memory, you need to have less than around $250K of superannuation (financial assets) and meet other income tests to receive the payment. Beware if your looking to claim the aged pension, then they begin to look at things like deeming an income from your super balance – regardless of whether your super is in the accumulation or pension phase. It is really important to get proper financial advice when it comes to making big decisions like this though, since there are so many factors at play here.
Additional things to consider before closing a mortgage
- Exit penalties or closure fees – these can sometimes be in the tens of thousands to break a fixed mortgage contract early!
- Your level of financial education – if finances and investing in general overwhelms you or you aren’t confident doing it, paying off your mortgage is a pretty safe bet that you can’t really go wrong with (even if it is not quite as lucrative as investing that money)
- Whether you have other debts with higher interest rates or repayments. Typically a mortgage is one of the lowest interest rate debts available, so it makes sense to pay off any credit card debts, personal loans or car loans first.
- Whether your financial situation may change after paying off the mortgage and you might need access to that equity – for example to fund renovations, travel, weddings, medical treatments or your lifestyle.
- Whether you might prefer a mortgage offset account or Line of Credit and keeping your mortgage open.
- Whether paying off your PPOR might bring your total financial assets below any means test thresholds for social security or welfare benefits.
How do I close my mortgage?
Once you have enough funds available to pay off the principle and any remaining interest, you need to engage with your lender or bank. They can provide you with a copy of your mortgage discharge authority form which is a fairly straightforward application. Once you complete and submit the application, the bank will accept payment for any outstanding balances (including any processing fee’s and penalties) and discharge (close) your mortgage.
The discharge process is important to closing your mortgage, as it formally removes your lenders legal rights or any caveats they have on or over your properties Certificate of Title. Completing it properly is important from a legal aspect, and will save you a lot of headache should you ever plan to sell your home or ever refinance to access your equity in the future.
Don’t expect this to be simple though, as most banks will do anything to keep your account on the books. When my Mum recently went to pay off her home loan, the credit union desperately wanted her to remain as a customer and keep the mortgage open with a ‘zero interest balance’ through an offset account. MoneyMagazine said this is highly typical, because “Your debt-free property looks good on their loan book“, adding that “most lenders have extremely good retention teams who will do everything they can to keep your account open”.
This process typically can take up to two to three weeks (including some waiting periods), and typically costs around $550 (including government discharge fees). Once the discharge application is approved and payment settled, you can then legally have the lender removed from the ‘deed’ of your property with the relevant land titles office.
What happens when I pay off my mortgage
“On that glorious day you head down to your local branch and, as you step through the automatic doors, you hear the fanfare of trumpets and see that all of the bank staff and customers are lined up forming a guard of honour for you to run through. As you reach the counter and high five the smiling teller, balloons and glittery confetti fall from the ceiling, everyone cheers, and then the bank manager pops a bottle of chilled Dom Pérignon….”Endevour Lotteries
Paying off your mortgage is exciting and can be a very proud moment, however it is also a bit of an anti-climax to be honest. After you have paid off your mortgage, nothing magical or significant happens…. other than maybe popping a champagne cork back home of course! Paying off the mortgage is more of a psychological thing than anything, and you will probably feel a big weight off your shoulders and more freedom – a feeling of which the importance of should not be understated.
One really important thing you will need to do after discharging the mortgage though, is to have your lender removed from the certificate of title of your property with your states land title office. You can find links to your relevant states land title office for more information below;
What should I do after paying off my mortgage
After paying off your mortgage, you should complete a financial health check. This should include reviewing and updating your;
- General insurance – including Home and contents insurance, automotive insurance and health insurance
- Superannuation policy and structures
- Income protection, TPD and life insurance. You might find you don’t need such a high level of cover anymore and can reduce your expenses in this area.
- Last will and testament
- Estate and family planning considerations
- Investments in other assets – Shares, Investment properties or buisnesses.
- Tax and accounting
- General expenses
Remember though, a mortgage is just one of many financial considerations for owning a house. Even once the mortgage is paid off, you will still need to include things in your budget like;
- Council rates and taxes
- Home and contents insurance
- Utilities such as Electricity, Water and Gas.
- The costs of heating and cooling your house
- General maintenance, repair and upkeep – usually at least 1% of the properties value each year (increases with the size and age of the house).
- Upkeep and operations of any unique or special facilities such as Swimming pools, Spas, Saunas, Rainwater harvesting systems, large gardens or lawns.
Typically though, not having to make mortgage repayments can free up your budget and allow you to look into;
- Travelling more
- Building up your emergency fund
- Reducing your working hours, or starting your own business
- Renovating your home
- Investing more into shares (or an investment property)
- Helping out family members
Does CaptainFI want to pay off his mortgage?
No. I want to maintain an interest only loan for as long as possible, in order to maximise cash flow on my investment properties. As the property grows in value, I gain equity and the Loan to Value ratio (LVR) decreases. This automatically lowers my risk over time, and gives me the option to refinance against the property should I ever want to use that equity for a deposit on another property.
However, for my future PPOR (the dream farm in the mountains) where I wan to raise my family, I think my answer would be yes I would want to have it paid off for peace of mind and housing security. That way, if I manage to stuff up all my investments at least I shouldn’t lose the family home.
Paying off the mortgage is the number one goal for many Australian property owners. For most of us, our mortgage is the biggest debt we will ever have in our lives, and dictates how we run our finances. Over 76% of Australian’s recognize that mortgage stress has a significant impact on their lifestyle, and paying off the mortgage would remove a significant financial burden and improve their quality of life. There are a number of ways you can pay off your mortgage in Australia quicker, including refinancing to a lower interest rate or shorter loan term, making extra repayments, contributing to (or parking savings in) a mortgage offset account, or even withdrawing a lump sum from your superannuation to pay off all or some of your mortgage.
It is just impossible to say whether you should or shouldn’t pay off your mortgage in general terms – it is such a personal question and really will depend on your individual personal circumstances, what you personally value, your risk appetite, levels of stress, and what your financial goals are.
Chatting to a Mortgage broker, or a qualified, independent fee-for-service financial adviser is a great way to get professional personal advice for your circumstances – usually the first session or two is free anyway so you haven’t got anything to lose except a few hours of your time. They can work through your specific situation and personal conditions to produce a tailor made report exploring your best way forward, including exploring the concept of risk adjusted returns.