Finance advice
Kate Cull

Should you pay off your home loan before you invest?

By Kate Forbes

There are plenty of options available to homeowners when it comes to managing your own mortgage.

Blogger: Kate Forbes, property strategist, Metropole Property Strategists

Most people are actively paying off both the principal and the interest, because that’s what they’ve always done.

But is that the best way forward for your investment property strategy?

Meet would-be investors Joanne and Richard (names changed for privacy).

They have had a home loan for three years and have decided to look into property investment.

Joanne has been told that because their home loan is ‘bad debt’, it’s best to pay it off first and create a bigger margin in their income, before taking out loans for other properties.

However, Richard thinks it would be best to pay interest only on their home loan, and use the amount they would have paid as principal towards some investment properties.

Who’s in the right here?

We’ll get to that in a moment…

First, clients often tell me that their financial advisors counselled them to pay off their own loan first before investing in property.

It’s true that home loans are a debt we want to get rid of – but I call this necessary debt, not bad debt.

And drip-feeding cash into your loan each week is a laboriously slow way of paying it off, and takes a large amount of your working life to get there.

Let’s look at Joanne and Richard’s situation and compare their options.

They have a 30-year home loan and are paying off the principal at an average of $10,000 a year.

This means that in 10 years, accounting for a little compounding, they will have paid somewhere in the vicinity of $120,000 to $150,000 off their loan.

Eventually they’ll pay it off, but it’s a slow method to getting there.

Option two paints a different picture.

Let’s say they borrowed some money (using the equity in their home as a deposit) and bought an investment property for $500,000, which increased in value over 10 years to become worth $1 million.

In 10 years, they’ve made $500,000 profit (at a growth rate of just over seven per cent).

So in the first scenario, they have paid, at most, $150,000 into their home loan.

In the second, they are $500,000 ahead because they used their money to service a loan for their investment rather than to pay down their home loan.

The end result?

Even if they didn’t invest in any other properties, they are far ahead and even though they still have a home loan, with inflation their loan is not as big a burden, and with the appreciation of the value of their home it’s a much smaller percentage of its value.

In other words their loan to value ratio would be much lower and manageable.

Of course they could always sell the investment to pay off their own home mortgage in full, but that’s a bit like killing the goose that lays the golden eggs.

The short story is, if Richard and Joanne wait to buy a property until their own home loan is paid, they are missing out on three decades' worth of future capital growth in a property they could have invested in.

That is why when people ask, “When’s the best time to invest in property?” my answer is always: as soon as you can!

Property investment is about the long-term.

It’s not about immediate wealth, and it’s not a get-rich-quick scheme.

As I said, sure paying off your home loan is an admirable goal, but it’s a very slow process.

It’s a bit like putting a little cash into a savings account each week. Yes, it’s a strategy to earn interest, but there are far better and more profitable ways to manage your money.

Many Australians are still paying off home loans long after retirement, which is never an idyllic way to spend your hard-earned twilight years.

The ideal way forward is to plan to pay off your home loan as soon as possible, but don’t do it at the expense of greater wealth in the long run.

You want to be buying a speedboat at 65, not funnelling your retirement money into your mortgage!

Let’s take our couple’s situation to another level

Imagine if they invested in several properties over the years, using the increased equity in their investment property and their home to qualify for more loans.
As their properties increase in value, they may even sell down and pay off their home loan in 10 years.

They now have even more margin in their budget to buy more properties.

In their home loan timeframe of 30 years, they now have a property portfolio of $3.5 million and they own their own home outright.

Or, if they chose to pay off their home loan first, they have simply paid off their home loan and 30 years' worth of interest, and have only just begun to invest in properties at age 55.

Whatever advice you’ve heard, take the time to research and properly investigate the best course of action for you and your personal situation.

Remember, if you wait 10 years to invest in property, you may miss a whole cycle of capital growth.

This will not only have a big impact on your bank balance, but will rob you of an opportunity to increase your asset base and work towards a financially healthy retirement.

But there’s one big proviso…

These recommendations are based on the assumption that you buy 'investment grade' properties – ones that exhibit superior capital growth.

 

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About the Blogger

Kate Forbes

Kate Forbes

Property Strategist at Metropole Property Strategists in Melbourne. She has 15 years of investment experience in financial markets in two continents, is qualified in multiple disciplines and is also a chartered financial analyst (CFA).

FROM THE WEB

podcast

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In this episode of the Smart Property Investment Show, Dominique Grubisa joins host Phil Tarrant to share her personal story which saw her hit rock bottom with excessive debt during the GFC.

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Dominique unpacks how, by relying on her background in law, she was able to overcome that debt and in doing so develop a unique investment strategy which she believes many can utilise today.

Dominique discusses distressed properties, and how she goes about finding them in order to buy property well below market value. She shares the process of identifying distressed properties as well as the controversy surrounding this buying method.

If you like this episode, show your support by rating us or leaving a review on iTunes (The Smart Property Investment Show) and by following Smart Property Investment on social media: FacebookTwitter and LinkedIn.

If you have any questions about what you heard today, any topics of interest you have in mind, or if you’d like to lend your voice to the show, email [email protected] for more insights!

RELATED AREAS OF INTEREST:

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More than just bricks and mortar, experts often regard property investment as a ‘game of finance’. As such, a good finance strategy can lead any investor to success.

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To hear more about these services, make sure to tune into this episode of Property Showcase!

 Make sure you never miss an episode by subscribing to us now on iTunes!

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    In this episode of Property Showcase, Michael Beresford joins editor of Wealth James Mitchell to unpack why recent political changes are not reason for concern for Australian investors.<\/p>\r\n

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Many investors who would have been successfully approved for finance last year are struggling now to either begin or continue their property investment journey because of the current financial climate.

In this episode of the Smart Property Investment Show, broker John Manciamelli and Momentum Media director Alex Whitlock joins host Tim Neary to discuss how APRA changes and the royal commission have resulted in a tighter lending economy and what that means for Australian investors.

They discuss what traps investors should avoid if they are trying to obtain finance, the four key growth drivers in a property market and unpacking trust structures while revealing one type of trust that you should miss.

If you like this episode, show your support by rating us or leaving a review on iTunes (The Smart Property Investment Show) and by following Smart Property Investment on social media: FacebookTwitter and LinkedIn.

If you have any questions about what you heard today, any topics of interest you have in mind, or if you’d like to lend your voice to the show, email [email protected] for more insights!

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AREAS MENTIONED:

Hobart
Bondi
Deception Bay

 

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More than just bricks and mortar, experts often regard property investment as a ‘game of finance’. As such, a good finance strategy can lead any investor to success.

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Getting finance approved in this tightening lending environment

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