David Johnston wrote this article for Domain, The Age and The Sydney Morning Herald on September 10, 2019
Most borrowers would understand that getting a low interest rate can save you hundreds of thousands of dollars over your lifetime.
What is not understood is how an effective mortgage strategy can actually make you hundreds of thousands of dollars over the same period. Borrowers don’t need to consult an expert to find a low rate. The only skill required is being able to use a search engine.
On the other hand, understanding how an effective mortgage strategy can create wealth is complex and not understood by most lending professionals, let alone consumers.
The top five mortgage strategies
In simple terms mortgage strategy is the utilisation of loan products and lender policy to enable you to grow your wealth and manage your risk to your optimal legal benefit. Although there are hundreds of strategies, most can be broken down into five broad categories.
1. Offset optimisation
Offset accounts are the banks’ greatest gift. For the uninitiated, an offset account is a special savings account where every dollar reduces the interest payable on your mortgage in the same way it would if paid into the loan.
Your savings are placed in an account in credit rather than reducing a loan which is an account in debit. The offset account is critical because it “greases the wheels” of many of the strategies and it provides clear delineation from your loans while reducing interest.
The offset can preserve future tax deductions, the ability to hold property, the effectiveness of buckets in a money management system and maintaining cash and cash flow to manage risk.
2. Money management
The management of your spending is vastly improved if you have a system that separates your spending into buckets, ideally using an offset account.
This allows you to set budgets and receive feedback for your different types of spending such as necessities, variable necessities and discretionary. Using this system you can categorise your expenses and receive weekly and monthly feedback.
Money management is critical because your remaining income after expenses determines your ability to pay off your debt and the level you can invest.
A mortgage strategy that incorporates a money management system tailored to your unique circumstances will not only increase wealth, it will reduce stress!
3. Optimising interest deductions
The only way to optimise your interest-related deductions is through borrowing to pay for investment and business purchases and expenses.
Common mistakes include not borrowing all expenses that are deductible. This can often be a double whammy because it can mean that you pay for deductible expenses in cash instead of preserving the cash to reduce non-deductible interest and debt.
Claiming interest on debt that was not used for the purpose claimed is another regular problem that rears its head. As is mixing deductible and non-deductible debt resulting in proportionately less deductible interest being able to be claimed.
Inaccurate loan balances are regularly problematic due to poor management and education by borrowers, lenders and brokers, often when a refinance occurs.
4. Risk management
Risk management comes in many forms and is vital for peace of mind. You can manage your risk in several ways:
creating buffers using equity, redraw and offset accounts
borrowing for asset purchases to maintain cash without paying extra interest due to the use of offset accounts
fixing interest rates on your debt to provide certainty
restructuring your repayments in advance of cash flow changes, such as parenting, employment changes and property purchases
depending on your circumstances, utilising one lender or multiple lenders or delinking mortgages. Alternatively, cross collateralising can be a positive subject to other strategies executed, contrary to popular opinion.
Prevention is always better than cure. The bigger the runway of available funds and surplus cash flow, the more time you will have to make decisions if you are ever under financial pressure. No one wants to have to sell a property when they could have held it through better forward planning and strategy.
5. Holding properties
Each of the four preceding strategies can positively impact your ability to hold property. You can optimise current and, importantly, future tax deductions, minimise debt on a future home while optimising deductions on an existing home when it becomes as investment. This requires aligning your mortgage strategy with your future property planning and goals.
Having to sell property you could have otherwise held over your lifetime is one of the big killers of financial wealth. Keeping property that you would have otherwise sold may literally add a million dollars or more to your bottom line in retirement. This is a mistake I made in my early years, and a prime example of the unrealised power of an effective mortgage strategy.
Why mortgage strategy is usually ignored
The largest expense in your lifetime is your mortgage, so why don’t we focus on our mortgage strategy?
The root cause is the perception that obtaining a mortgage is a free service, meaning most consumers do not equate a value to obtaining mortgage strategy.
The provision of a mortgage does come with a fee. The profit generated from the sale of a mortgage is paid by the borrower via the interest rate, loan set-up and ongoing fees. This income is then paid to investors or savers who lend the money, as well as covering staff and brokers’ commission, with the remainder making up much of banks’ profits.
The income is not readily transparent to the borrower other than a payment to the mortgage brokers who are obliged to disclose the fee or commission paid.
Compounding this is the complexity of many strategies. As an example, borrowers often confuse the concept of redraw with an offset account, and most strategies require a sound understanding of the difference between both as a starting point.
In the age of instant gratification, garnering trust in advice that is based, at least partly, on outcomes that are not measurable today, and may not eventuate, can be a leap of faith too far for some.
For these reasons mortgage product distributors largely focus on products, rates and providing support during the mortgage and purchasing process. It is without doubt simpler to take this approach, and it’s what most borrowers expect, and therefore want, but that doesn’t necessarily make it the best approach.
Why mortgage strategy should come first
Your mortgage and banking strategy will have a profound impact on your cash flow and your financial, property and investment opportunities.
If managed well, it can allow acquisition of assets, superior money management and a stable financial situation. If paid scant attention and you get it wrong, the cost of selling assets, lost tax deductions, an inability to accumulate assets, poor money management, increased interest costs and stress levels can be astronomical.
Determining your mortgage strategy should therefore be priority one. You can always access a great rate after you determine your mortgage strategy, but not every lender will be able to accommodate the strategy that is right for you.
All mortgage brokers and lenders can access the same rates. There will always be a new lowest rate, and it is not practical to refinance weekly, monthly or even yearly.
It is also impractical to develop a mortgage strategy yourself. It takes years for an experienced mortgage broker to master the skill of mortgage strategy, and they are doing the job full-time. Whereas it takes no mortgage experience to know that 3.8 per cent is lower than 3.81 per cent.
Every investment decision requires a leap of faith and it is worth remembering that these strategies can be put in place at no direct fee other than your time, understanding and selecting lenders who will accommodate your strategy.
An effective mortgage strategy will play a significant role in ensuring that you reach the flexibility stage of life with peace of mind if you follow three steps:
1. Plan – Determine your property, investment and lifestyle goals and preferred money management system.
2. Strategy – Determine the mortgage strategies that suit your current situation with an eye to your future plans.
3. Select – Then select a lender who can implement your mortgage strategy and provide a great rate.
You should revisit your mortgage strategies regularly with your strategic mortgage broker as your financial situation or future plans change and evolve.
While you can get a mortgage without paying a fee to the person providing the service, do not underestimate the value of your mortgage strategy, as the decisions you make today will impact your wealth and lifestyle for many years to come.
“Five mortgage strategies that can grow your wealth” was first published Domain, The Age and The Sydney Morning Herald on September 10, 2019.