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).

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podcast

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Will Magee has had ambitions to enter into the Australian property market for quite some time, but it has been more than just finances holding him back.  Having been granted permanent residency just two weeks ago, Will is wasting no time and is now in the process of signing papers and finding his first investment property.

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In this episode of the Smart Property Investment Show, Will joins host Phil Tarrant to share why he is purchasing his first property in partnership with his brother, discuss the complications that can arise from such a strategy, and unpack the ongoing plan for building a joint property portfolio with his brother.

Will will also share how they approached saving for their first property, why he is taking out the mortgage in his name exclusively, and share their savings plan for the year ahead.

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:

From property in Australia to a ski lodge in Japan
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Should a real estate title be in one person’s name only?

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A property investment plan years in the making
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Median house prices in regional Victoria outperformed that of Melbourne in the June quarter, the latest REIV figures reveal. 

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Median house prices in the regions rose 4.0 per cent to $419,500 but in Melbourne they dipped by 0.6 of a percentage point to $840,000.

The result in Melbourne was due to a 0.8 of a percentage point fall in prices achieved at auction; this was despite a lift of 2.3 per cent in private sales.

Inner Melbourne suffered due to auction prices, where median prices fell by 4.9 per cent to $1,459,000 but it was middle Melbourne that was hardest hit, with a 5.4 per cent drop to $974,500.

Outer Melbourne had a good quarter with the median rising by 0.5 of a percentage point to $681,000.

Apartment prices in regional Victoria grew by 3.7 per cent to $304,500 while the metro media was up by 0.5 of a percentage point to $604,000.

REIV President Richard Simpson said that despite fewer sales, many sectors of the market were performing well.

“2017 was a bumper year and while the trendline has flattened, despite the fall in median house prices in the June quarter, median prices are still up this calendar year for both houses and units, in Melbourne and in the regions,” Mr Simpson said. 

In particular there was been strong growth in regional centres which is probably due to the first-home buyers’ concessions said Mr Simpsons.

“The first-home buyers’ concession has been a boon for regional areas. A new entrant to the property market buying a house at the regional median will pay no stamp duty, while a first home buyer of an apartment in Melbourne at the median price would pay stamp duty of nearly $25,000,” he said.

Mr Simpson said that more prospective buyers are looking towards regional Victoria which is also having an effect in Melbourne.

“Melbourne’s outer perimeter continues to grow. Small increases in the June quarter mean that the median prices for both houses and units have risen over 10.5 per cent from a year ago.

Mr Simpson said moving forward that vendors need more realistic expectations as the highs of 2017 are now over.

“Negative chatter about the future of the sector coupled with stronger lending controls by financial institutions has created some uncertainty and vendors need to be realistic with their price expectations,” Mr Simpson said.

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Regional Victoria showing up Melbourne in price performance, new data finds
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  string(381) "

If Mark Hodge’s face looks familiar to you it could be because of his time working as a professional entertainer which saw him working with the Australian ballet, appearing on multiple seasons of Dancing with the Stars and touring in musical theatre for 17 years. What you may not know is that Mark is also heavily involved in the short-term property rental marketspace.

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Mark joins host Phil Tarrant to discuss his transition from entertainer to investor, a journey pushed forward by dance related injuries and even a hit and run which saw him needing to find alternate methods to bring in an income. Mark shares how bad long-term tenants and a gang member guided him to the short-term rental market, and how this pushed him into helping others to realise the same benefits.

Mark will also address the common concerns, discuss what his company Maisonnets specialise in and unpack how they are making the process of filling short term rentals easier for investors.

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:

Melbourne
Sydney
Rushcutters Bay
Maroubra
Potts Point

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From pirouettes to property investment

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