Is it better to pay off your home first before investing in property?
Most people’s gut reaction is that paying off their mortgage should be the priority. While this sentiment is understandable, it may actually be preventing people from getting ahead financially.
Once you have about 40 per cent equity in your home, that’s usually enough to secure another loan to invest in property without having to use cash savings. A good property investment adviser can help you find an investment property in an area forecast for solid growth that also has enough rental income and tax benefits to cover the interest and all associated costs so the property is cash flow positive.
The property market has averaged close to a 9 per cent return over the last 60+ years, so, if for some reason there is only half that historical growth, you would still be far better off financially investing in property before paying off your home.
Imagine someone has a home worth $1,000,000 with a $600,000 mortgage. If they use the equity to invest in a $1,000,000 investment property (or two $500,000 investment properties) the new loan/s would need to be $1,000,000 plus approx. $50,000 in stamp duty, legals and advice, so $1,050,000 total. They could also borrow an additional $50,000 cash reserve buffer to help manage future risks. If the rent and tax benefits are enough to cover the interest and costs, and still be $200 per week cash flow positive, that can provide $10,000 a year towards paying off their home loan, whilst building a bigger cash reserve buffer.
If the property grows by an average of 5 per cent per annum, that’s an additional $50,000 per annum capital growth. After 15 years, that is $750,000 of growth plus $150,000 of cash flow from the annual $10,000, so $900,0000 total return. If you then sold, even after capital gains tax and costs, you would have far more than you need to pay off your $600,000 home loan in less than half the time it would normally take.
Rent increases, compounding and reducing interest usually make the above scenario even more effective, and you can usually invest in more property as your income and equity grows.
This is not to say that people should forget about paying off their mortgage with extra payments. Pay it off as quickly as you can comfortably, particularly in the early stages, while checking the value of the property regularly. The key is to treat your home as an asset and to use it as leverage to buy other assets where you can safely.