BusinessDesk investments editor Frances Cook responds to emails from readers each week to answer questions about money. Below, you will find her expert advice. Send your own questions to [email protected].
Hey Frances,
This is a bit of a weird one, given the current economic climate. We have two mortgages, a smaller, shorter-term one that we pay down in chunks when it comes up for renewal (as well as a fortnightly minimum payment obvs!) and a bigger one that just rolls over and over and we pay a bit more than the minimum each fortnight.
We now have the ability to pay more off each week, but my question is: should we pay more off the smaller one or the larger one? We’re with a bank that gives us plenty of flex in what we can pay, without being penalised.
Thank you,
S
Hi S,
That sounds like a good problem to have. Paying off extra on the mortgage can be really powerful for getting ahead, even if the extra payments are small.
So, we’re in the happy situation of choosing between options where none of it is bad; we’re just looking for the best version for you. My favourite type of problem.
I can answer your immediate question, but I also want to suggest another way that you may not have considered.
The immediate question
You don’t say what interest rates you’re paying on each but, generally, shorter-term mortgage rates are cheaper.
So, what we have here is a version of the snowball v avalanche debt technique.
Mathematically, it’s always best to put more money into the debt that has the highest interest rate. This is the avalanche debt technique.
You put all extra money onto the debt with the highest interest, saving yourself the most money overall, and getting ahead faster.
However, there’s also human nature to consider.
The snowball technique means focusing your extra effort on the smallest debt, whatever the interest rate is.
You’ll pay it off and be able to clear it entirely, giving yourself a happy buzz of motivation that could spur you on to further efforts.
The most important factor is simply that you make extra payments on the debt. Whether snowball or avalanche appeals to you more, it doesn’t matter.
What matters is that you pick one, and attack that debt.
But
There’s also another possibility that you haven’t raised, which could be a good one. It also depends on your money personality.
Have you considered a revolving credit mortgage? They can be very helpful to clear a mortgage fast, as long as you’re disciplined with credit.
I reached out to Enable Me’s Hannah McQueen, and she also suggested a revolving credit. So, I’m going to let her kick off the topic, and then I’ll add my two cents afterwards.
This might sound strange, but I’m going to tell you – neither.
While the bank gives you the flexibility to repay chunks of your mortgage without penalty, that’s where the flexibility ends.
If you wanted to access that money to invest elsewhere, or if your circumstances changed and you actually needed that money back, that’s often when the bank is less inclined to help!
Instead, I’d be wanting to get a really good handle on what your repayment potential is each year and then would look to set up a revolving credit of the same amount. That gives you a target to work towards and offsets interest costs but, crucially, maintains your flexibility to access that money should you need or want it.
I’d also revert to minimum fixed repayments on the fixed loans for the same reason. To reduce your minimum payment further, I would encourage you to extend the term of the mortgage. But this is only if you are needing to grow wealth in addition to repaying your mortgage faster.
A good financial management system is required to make sure the revolving credit doesn’t just become a giant overdraft you never repay, as that defeats its purpose.
While the high floating interest rate might scare you, if you pay it down consistently the effective interest rate is much lower (which is also why you don’t want it to be any larger than what you can afford to repay).
The debt that forms the revolving credit should be broken off the loan that has the highest interest rate – if a loan is coming up for fixing now, it’s likely that’s about to be your highest interest rate.
If the interest rates are the same, I’d break it off the loan that is currently costing you the most.
Hannah makes a good point. The revolving credit basically functions like an overdraft, at floating interest rates.
This means you can put extra money into it with abandon, knowing that if something unexpected happens (like a job loss), you can get that money back out without applying to the bank for an increase to your mortgage.
There are some cons to this.
The revolving credit will be at a slightly higher interest rate, as it’s floating. This means that you need to be sure you’ll actually be making those extra payments, otherwise, it will cost you more.
Consider automating those extra payments to make sure you stick to them.
You also have to be disciplined to not take the money back out. The flip side of knowing that you can access that money in an emergency is that you can also access it in non-emergencies. If you do that, you’ll undo all of your good work and go backwards instead.
If you’re someone who’s not good with credit cards or overdrafts, no shame in that. Some of us simply aren’t.
The more important thing is to simply acknowledge that and organise your money so you’re not tempted. A revolving credit wouldn’t work if that’s your money personality.
In which case, the snowball or avalanche approach will be your best bet.
So, now the question simply is, which one do you think will work for your personality?
Send questions to [email protected] if you want to be featured in the column. Emails should be about 200 words, and we won't publish your name. Unfortunately, Frances is not able to respond to every email received or offer individual financial advice.
Information in this column is general in nature and should not be taken as individual financial advice. Frances Cook and BusinessDesk are not responsible for any loss a reader may suffer.
