We have been told that our home loan is the first one we should get rid of. After all, it is the biggest debt, 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 home loan completely before considering other investments such as buying an investment property?
For some people, this may make sense. If you want a low-risk profile, can see your income going down in the future or there are other reasons why you want to get rid of this 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 will pay a big cost.
This is known as an opportunity cost. This is simply a way of saying – how much will it cost you to wait 10 or 20 or 30 years before you start investing? How much profit and market growth will you miss out on by waiting?
If you bought a home in Sydney 10 years ago and waited until you paid it off before you invested in property, you would still be waiting to buy another investment. It would be at least 5 or 10 years, if not more, before owning it outright. BUT if you used some of your equity to buy an investment property 3 or 4 years ago, you would have 2 quality property assets that have both gone through a massive growth spurt. Your wealth would be greater with 2 properties than it would be with 1, even though you have more debt.
The extra wealth of profit is the “opportunity cost” you miss out on if you wait for util your home loan is paid off.
How Can You Safely Invest Before You Own Your Home Outright?
How can an investor use their home equity safely, so it does not impact their lifestyle and enables them to buy a property at the same time?
Our suggestion is that people pay off their home loans 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 us explain… 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 home to use as a deposit and stamp duty on an investment property.
Here are 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 will repay the principal debt from day 1.
- 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 to Know About?
Over the years we have seen a similar 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 we have seen is that borrowers fall into is include using redraw, causing them to lose tax advantages, taking out principal and interest loans on an investment loan that is not tax-effective, or they don’t think about using the equity they have built on their properties to use on purchasing investment properties.
To best leverage your loans for both your home and investment properties, it is ideal to set up the right structures and loan features from the beginning. Working with a mortgage broker and an accountant can be so powerful – it can save you from making mistakes that could cost you thousands, tens of thousands or even hundreds of thousands in lost profits, missed opportunities and unnecessary fees.
If you are interested in property investment but don’t know where to start or whether you should pay off your home loans first, feel free to get in contact with our friendly team today and we can help look
Phone: 1300 855 022
Zippy Financial is an award-winning mortgage brokerage specialising in home loans, property investment, commercial lending, and vehicle & asset finance. Whether you are looking to buy your first home, refinance or build your property investment portfolio, the team at Zippy Financial can help find and secure the right loan for you and your business.
About the author:
Louisa Sanghera is an award-winning mortgage broker and Director at Zippy Financial. Louisa founded Zippy Financial with the goal of helping clients grow their wealth through smart property and business financing. Louisa utilises her expert financial knowledge, vision for exceptional customer service and passion for property to help her clients achieve their lifestyle and financial goals. Louisa is an experienced speaker, financial commentator, mortgage broker industry representative and small business advocate.
Connect with Louisa on Linkedin.
Louisa Sanghera is a Credit Representative (437236) of Mortgage Specialists Pty Ltd (Australian Credit Licence No. 387025).
Disclaimer: This article contains information that is general in nature. It does not consider the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information. This article is not to be used in place of professional advice, whether business, health or financial.