Invest in property or pay off your home?

I would have to say this is one of the questions that produces the most amount of discussion when I am talking to new investors and in all honesty, my response tends to make many people uncomfortable! Let me explain why.

When we were younger most of our parents brought us up telling us that we should pay off our homes as quickly as possible and that if we did this we would be in a better position financially later in life. Sound familiar? Well they were kind of right, however how many of you reading this would have parents who own a freehold home in retirement but still rely on the government to support them to live and pay the bills. Most of our parents are now asset rich in the form of their own home however have little money in the bank for day to day living and many of them have had to change their lives significantly in retirement. They were so obsessed to be debt free that they hadn't planned how they would pay to live for their second phase of life.

Many people have been led to believe "debt is bad" and this has cost them thousands of dollars. The facts are there is "bad debt" but there is also "good debt' and we all need to understand the difference if we want to change the outcome of our lives in retirement. So let's take a look at Bad debt VS Good debt.

Bad debt

This is normally when we borrow money for items that depreciate (decrease) in value without giving us growth in assets. Now don't get me wrong, there are some debts that we need however it's how we mange it that counts. A good example is borrowing money for a car. If you buy a car and drive it until it reaches it's used by date and you need it to travel to work and for pleasure that's fine. However if you buy a new car every 3-4 years and aren't able to claim any tax deductions against the money borrowed, then this would be seen as bad debt. Another form of bad debt is booking up items on your credit card that you don't really need. Because you have access to "extra money" in the form of credit, you may tend to buy items just because you can but that you wouldn't normally buy and this creates bad debt.

Good debt

This is when you borrow money for an item that will appreciate (increase) in value over time or produces an avenue for you to save money. Buying a painting that will increase in value or a coin collection would be seen as good debt. Property is also a perfect asset that can be purchased and is seen as good debt. Over time the property will increase in value and you will eventually become wealthier through the growth in asset especially if it's your own home as there is currently no tax paid on the profit of the home you reside in.

Even better debt is an investment property as you now have other people helping you pay the debt off. Firstly you have the tenant that pays you rent and then you have the taxman that will give you tax relief in the way of tax deductions.

So, were mum and dad right?

Yes and no. Initially it's a good idea to put money into your own home to reduce your debt. This gives you some security or breathing space to cover you in case you need money in a hurry in the future for whatever life throws at you. However how much we pay off is the important part of the point I'm trying to make.

At some stage we all need to build wealth if we want to live a comfortable life in retirement. Personally I don't want to change too much when I eventually retire and I have been planning my retirement since I was 24 years old. Why 24 you ask? Well that's when I bought my first investment property and starting building my wealth.

What we all need to understand is that there is a huge difference between paying debt off and building wealth and unfortunately not too many people know the difference. You can't spend money in retirement if you don't have any and if you spend all your life paying off your own home then what happens then? Do you sell your home and rent and live on that money? Do you scale down your property size and buy something smaller to free up money? Do you become more frugal with your money to make any savings last? Take a look at how much Superannuation you have. Do you really think you'll have enough to live comfortably on? What's your plan? Chances are that you don't have one which is extremely disturbing however most people try not to think about it until it's too late.

Ok, let me show you a really simple formula to show how paying off your mortgage can cost you money and in most cases tens of thousands of dollars.

Let's say you have a mortgage of $200,000 and you borrowed the money 5 years ago. Your repayments would be around $1,450 per month which would see your home loan paid off in another 25 years. Now of the $1450 most of that is interest and about $300 is coming off of your principle (in other words reducing your mortgage) so it's going to take 25 years to pay the loan off.

Plan A is to now pay an extra $400 per month of the loan as voluntary payments. After 12 months you would have paid an extra $4800 off of your loan which sounds good doesn't it? Maybe not!

Plan B Now let's do something different and put that $400 per month towards buying a brand new investment property in Adelaide.

In South Australia the average property has increased by 8% per year over the last 80 years according to the Australian Bureau of Statistics. So if we use history as our guide and bought a $320,000 investment property, 8% growth equates to $25,600 per year.

That's right, put $4800 towards your home or build $25,600 of wealth.

$4800 paid off our debt or $25,600 in asset growth hmmmmm; let me think about that for a minute.....

So let's keep doing the numbers to see how this looks after say 9 years;

Monthly Additional Payment   8% Investment Property Value Increase Property Value Growth
$0   $320,000 $0
$4800 or $345,600 $25,600 yr 1
$4800 or $373,248 $27,648 yr 2
$4800 or $403,107 $29,859 yr 3
$4800 or $435,355 $32,248 yr 4
$4800 or $470,183 $34,828 yr 5
$4800 or $507,798 $37,614 yr 6
$4800 or $548,422 $40,623 yr 7
$4800 or $592,295 $43,873 yr 8
$4800 or $640,000 $47,383 yr 9
$43,200 Total Savings or   $320,000 Total Growth

In the left column you have $43,200 in savings which is the total amount that you would have paid off your home loan after 9 years.

And in the right column you have the total amount of $320,000 of asset growth that you would have by purchasing an investment property which has grown at an average of 8% per year which we have used as historical growth for this example.

The net result is that if you had not paid any money off of your home loan and re directed this money towards your first investment property then after 9 years you would be a massive . . . .

$276,800 better off!

Property growth of $320,000 less the total funds paid off mortgage $43,200 = $276,800 difference.

Does it really matter now whether you have paid your $200,000 home loan over the next 20 years?

The facts are that using this example, your wealth will increase by more than your total debt against your home in just 9 years.

Now imagine if you could afford to buy 2 or even 3 properties between now and retirement!!

Remember this is an example only and there are many other factors which include interest savings on your loan that need to be taken into consideration which we would be happy to explain to you in person. You should also talk to your accountant and/or financial advisor to ensure investing in property is suitable to your individual circumstances.


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