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People are often keen to get rid of the debt hanging over their family home, so they invest a lot of time and money paying it down – but there is a smarter (and easier) way.
Blogger: Cam McLellan, director, OpenCorp
Many people feel the need to be debt-free and their only financial goal is to pay off the family home. For those who feel this way, this post is for you.
From time to time you will hear people toss around the saying ‘work smarter, not harder’. But the majority of people don’t do this. Instead, they work hard to pay off the family home with income they earn from a job. And that is a big waste of time.
The definition of lunacy is doing the same thing over and over and expecting a different result - Albert Einstein
I realise most people have been conditioned to think this way by their parents and society as a whole. But that doesn’t make it a viable strategy. I’ll give you an example that shows why paying off the family home over 25 or 30 years with earned income is a bad strategy.
Let’s say you only ever buy three properties in your life.
Two well-chosen investment properties bought at $500,000 each and the family home also bought for $500,000.
Investment property value: $1,000,000
Family home value: $500,000
Total property value: $1,500,000
For simplicity’s sake we’ll assume the total loan amount is also $1,500,000.
Remember tax breaks and rental income will help you fund most of the loan repayments.
As we know, well-chosen property will double in value about every seven to 10 years. That being the case, all you need to do to become debt-free is to hold the investment properties through one full growth cycle, then sell them.
This means your two investment properties will increase in value from $1,000,000 to $2,000,000. If you were to sell the two investment properties at this point for $2,000,000 you would incur capital gains tax of 25 per cent on the profit from the sales (25 per cent rather than 50 per cent as these properties will have been held for a period longer than 12 months). The remaining amount available to reduce debt after tax will be $1,750,000.
You can now pay back the $1,500,000 debt on the investment properties and your own home, leaving you with $250,000 to play with. I’m sure you’ll think of something to do with the extra money.
This is a simple example of what you can do, though it’s not the strategy I recommend. Remember, if the rent is covering the repayments on your portfolio, then what you have is good debt. It’s worth examining whether your desire to reduce debt is due to society's deep-seated belief that all debt is bad.
Either way, I hope this example saves you many years of hard work.