By Guest Blogger, Louisa Sanghera, Principal Broker,
Zippy Financial
We’ve long been told that our home debt is the first one we get rid of.
After all, it’s our biggest debt. It’s a ball and chain, dragging you down by the ankles, shackling you to expensive payments for decades. So, it makes sense that most people want to pay it off as quickly as possible.
But is that really the smartest way to manage your finances?
Should homeowners pay off their mortgage completely before they consider other investments, like buying investment property or investing in shares?
For some people, this might make sense. If you have a really low risk profile, can foresee your income going down in the future or there are other compelling reasons why you want to rid yourself of your mortgage debt, then it could be the right way to go.
But when you avoid investing because you want to pay off your home loan first, you pay a big cost.
It’s known as an opportunity cost.
This is simply a way of saying: how much will it cost you to wait 10 or 20 or even 30 years before you start investing?
How much profit and market growth will you miss out on, by waiting?
Consider it this way: if you bought a home in Sydney 10 years ago, and waited until you had it fully paid offer before you invested in property, you’d still be waiting to buy another investment. In fact, you’d probably still be 5 years, 10 years or even further from owning it outright.
But if you’d used some of your equity to buy an investment property 3 or 4 years ago, you’d have 2 quality property assets that have both gone through a massive growth spurt.
Your wealth would be far greater with 2 properties than it was with 1, even though you’ve taken on more debt.
That extra wealth of profit is the “opportunity cost” you miss out on, if you wait until your home is fully paid off to invest.
How can you safely invest before you own your home outright?
How can an investor use their home equity safely, so it doesn’t impact their lifestyle and enables them to buy a property (or even build a portfolio of properties) at the same time?
My suggestion is that people should pay off their home loan enough to be able to avoid paying Lenders Mortgage Insurance.
This means you want to borrow no more than 80% of your property’s total value, when you withdraw some equity to buy an investment property.
Let’s say your home is worth $800,000 and your loan is $500,000. A loan worth 80% of its total value is $640,000.
You owe $500,000, so you can borrow another $140,000 against your own home to use as a deposit and stamp duty on and investment property.
A few tips for people who are considering this strategy:
• Always take out a principal and interest loan on an owner occupied property: this means you’re repaying the principal debt from day 1.
• And take out an interest only loan on an investment property. This is a tax-deductible debt and principal payments are not deductible, so this is the smartest way to leverage your money.
• Any extra money you would have paid into your interest only debt, should be paid into your personal home loan. This way, you repay the non-taxable debt even sooner.
What are the traps the inexperienced should know about?
Over the years, I’ve seen a familiar pattern play out in that inexperienced people don’t structure their debt correctly and end up with loan products that don't suit them or that restrict their borrowing capacity.
Other traps I’ve seen inexperienced borrowers fall into is using redraw, causing them to lose tax advantages – or they take out principal and interest loans on an investment loan, which isn’t tax effective.
Lastly, they don’t think about using the equity they’ve built in their properties to use on purchasing investment properties.
To best leverage your loans for both your home and investment properties, it’s ideal to set up the right structures and loan features at the beginning. This is why working with a mortgage broker and an accountant can be so powerful ¬– it can save you from making mistakes now, that could cost you thousands, tens of thousands or even hundreds of thousands in lost profits, missed opportunities and unnecessary fees down the track.
Louisa Sanghera - Director and Principal Award-Winning mortgage broker at Zippy Financial
Louisa created Zippy Financial after a 25-year career in banking, with the goal of using her expert financial knowledge, vision for exceptional customer service and passion for property to help her clients grow their wealth through smart property financing. Whether you are looking to buy your first home, re-finance or build your property investment portfolio, Louisa and her team of experienced brokers can help guide you through the challenging maze of finding & securing exactly the right loan for you.
M: 0414083522 or 1300 855 022
E: louisa@zippyfinancial.com.au
Connect with Louisa Sanghera on LinkedIn
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