As it turns out, these two options don’t have to be mutually exclusive.
You can have the best of both worlds.
If your mortgage has a redraw facility or an offset account, you can pay down your mortgage quickly, saving money on interest whilst building a potential emergency fund at the same time.
An emergency fund: why you need one
According to a recent article, more than a quarter of households [surveyed] admitted that they would run into financial difficulty if they lost their jobs.
Job loss is a scary thought. How would you pay the bills, keep a roof over your head and put food on the table if you lost your job tomorrow and it took months for you to find a new job?
Even in good economic times, businesses fold. Or downsize. Or restructure.
People get ill or have accidents.
Your emergency fund is your peace of mind. It’s your insurance against future risk. It is there to cover unexpected setbacks and take the financial stress out a bad situation.
Extra mortgage repayments: why you should make them
If you have a mortgage, small extra repayments add up to BIG savings in interest over the course of a loan.
Take the average $400,000 mortgage with a 30 year term and with interest at 7%. Making fortnightly repayments and paying an extra $10 each fortnight will save you a whopping $151,432 over the course of the loan (which will be reduced to 23 years!)[Online calculator here].
That’s no small change.
If you were to try and save $20 a month towards your emergency fund instead, it would take you 82 years to save $150,000 (at 4% interest) and the interest earned on those savings would be taxable [calculator].
Make your mortgage your emergency fund
So here’s how it works: you make extra repayments on your mortgage and reap the benefits.
If you lose your job and you need funds, then you can redraw these extra repayments. Your extra repayments transform into your emergency fund in the event of an emergency.
There are, however, a few practicalities that you need to consider.
First, you need to check with your lender that your mortgage allows extra repayments and has a redraw facility or an offset account. If you do have these facilities, check whether there are any fees or rules when using them.
Secondly, it’s important to note that you may not be able to redraw funds during a fixed interest period without breaking the contract and generating break fees. Ask your lender to disclose possible break fees and take these into consideration when deciding on a fixed period.
If you’re in the market for a new mortgage, make sure you take these things into consideration.
It is best to be aware of your choices before you need them, so take the time now to understand how your mortgage works – it will save you stress and heartache later if you ever do find yourself in a bad situation.
The hidden benefit to building an emergency fund this way is that you don’t have money sitting in the bank, tempting you to spend it. You may, however, still want to have a month’s worth of expenses in a bank account for quick cash flow, to cover any time it might take to redraw funds from your mortgage or in the case of small emergencies.
So if you’re asking yourself whether you should put your energy into building an emergency fund or into paying your mortgage down as quickly as possible, remember that there’s a third option – doing both.