If only I had $1 for every time I had heard the question: Is it better to pay off your home first before investing in property?
The gut reaction of most people is that paying off their mortgage must be the priority. While I understand the sentiment behind such thinking – “I just want to be mortgage-free” – it may be stopping a lot of them from successfully investing in property and building true wealth.
Let’s look at the facts. You only need about 2 per cent capital growth a year from an investment property for it to significantly outperform the results from paying off your home – and the property market has averaged close to a 9 per cent return in recent years! So even if for some curious reason the outcome is only half that historical growth, you would still be far better off financially.
Such mathematics can be ignored – at great cost – because of people’s emotional attachment to the notion of paying off their mortgage and owning their own home outright. The irony is that you could probably pay off your home off in less than half the time by selling the investment property, without having had to pay any higher repayments.
Of course, there are some risks if the property markets deliver no capital growth, but this is a rare case and an experienced property investment advisor can put in place strategies to balance your investment risk with opportunity cost risk.
Still not convinced? Let’s look at the scenario in more detail. For a person on about $80,000 taxable income or more, a $500,000 investment property costs about $100 a week after rent and tax at average interest rates of about 6.8 per cent. However, this drops to about $5 or less a week at the current interest rates of about 4.99 per cent fixed for five years.
If you put $100 a week into an offset account, or as an extra repayment on your mortgage, it will only save you about $180 interest that year! Contrast that with the investment property growing at 2 per cent; that is $10,000 growth, or 55 times better than the $180 interest saved! If the investment property grows at 5 per cent, that represents $25,000 growth, or 138 times better than $180 interest saved!
This is not to say that people should forget about paying off their mortgage. Pay it off as quickly as you can, particularly in the early stages, while checking the value of the property regularly. When you have built up sufficient equity, then you will be in a position to consider further property investments. The key is to treat your home as an asset and to use it as leverage to buy other assets.
Education is crucial. Knowing the facts and doing the maths often gives people the motivation to save quickly and seek advice about the best strategies and areas in which to buy. Then they are well placed to build equity and wealth – faster and with fewer risks!
This article was originally written by Richard Sheppard for the November 2014 issue of Peninsula Living Magazine.