Should I Pay Off My Home Loan Before Investing in Property?

property investment melbourne - home loan or invest (2)

 

 

 

 

 

 

 

 

This question is one which comes up time and time again for many. It can create some great dialogue and almost always ends up with a room divided on their views. So which is the right answer?

The reality is that both answers can be right and both can be wrong. Why? Because it’s a very open question. Everyone’s individual situation and objectives are different, and unless you apply it to your particular situation, it’s almost impossible to get a definitive answer.

If your primary objective is to simply pay off your home loan as soon as possible, even if it may not be the most financially beneficial strategy, then that’s your answer.

But, if we look at it from a purely financial perspective, we can let the numbers provide some guidance.

Some may suggest that interest on your mortgage is ‘dead money’, which I will not argue. Unlike investment properties where the interest you pay is tax deductable, this is not an option for your primary place of residence.  I will also not argue that you would be better placed by paying off more principal in order to reduce the interest payable on your home loan. That strategy in isolation makes total sense, but when you throw a property investment opportunity into the mix, the assessment changes.

The easiest way to assess this is to simply assume you have enough equity in your current home to draw another loan for an investment property (Let’s say you draw $100,000). At 5% interest that’s $5000 per year in additional interest. More dead money, or is it?

For $100,000 you could invest in a property worth around $400,000 (ie $80k for 20% deposit plus say $20k acquisition costs, leaving $320k debt at 5% interest only).

If you choose the right property, your rent and tax benefits should offset the interest payable on your $320k debt, so we can put that aside for this comparison.

We then look at the main reason why people prefer to invest in property, and that is the capital growth and the leverage you have with property investment.  Knowing that property increases in value over time, after 1 year, at 7% growth rate your property has increased in value by $28,000. Even at 5% growth it’s still $20,000.

To gain that $20,000 it has cost you $5000 in additional interest on your home loan, so you would be at least $15,000 ahead after 1 year by taking the decision to invest.

And better still, instead of buying an established property, when you take the developing investor approach, you can create enough additional equity to allow your $100,000 drawn from your home to be paid out, meaning no more additional interest on your home loan and maximum capital gain from your property investment.

Please contact us if you have any questions or want some assistance with the property development and investment strategies available to you.