The full title of this article is really…
Why you shouldn’t pay off your home mortgage when you have a house but invest in assets instead
Ok – now that I have your attention I hear you ask- Why shouldn’t I pay off our home mortgage?- that is what our parents did, isn’t it?
Our parents worked, bought a nice house in the suburbs –and now 25 years later it is paid off (or nearly) and if they sold it they would make a lot of money (which would probably be exempt from capital gains because it has been their main residence the whole time).
Rich people think differently to middle class
So isn’t paying off your mortgage smart financial advice? Well Yes and No.
Paying off your mortgage is a lot better than blowing your money on clothes, coffee and the gym membership (or whatever you spend your money on).
And your accountant will often tell you to pay off your mortgage to reduce non-tax deductible debt (as if you are paying interest – if you can get a tax deduction for it you can get a refund of 30% – or whatever your marginal tax rate is).
An idea that is different to the masses
However – what if you were to switch your home loan to be interest only and never pay it off?
And with the extra money saved by making principal repayments (which might be a few hundred dollars a month) – buy an investment property (or better yet a few!).
Here’s how it works
Option A- Pay off your home: If you bought your unit/house at 400,000 – in 30 years you would have paid off the home loan. Also the house would have gone up in value. If the house increased by 3.25% a year on average (e.g. year one worth $400k x 3.25% = $413,000, Year 2, $426,423, etc.) by the 30th year it would be worth $889,839 by my calcs. Estimated Home future value. So your NET WORTH (assets less liabilities) would be $889,839 house (as you have paid off the loan (less property selling costs).
Option B - Invest in More Properties If however you switched your loan to interest only your home would be still worth $889,839 and you would still have the $400,000 loan = so if you sold your home (net home) you would get $489,839 less costs.
BUT WAIT… if you purchased the house next door for 400,000 – then at the end of the day you would have equity on the 2nd property of $489,839.
489,839 x 2 =$979,678 (less selling costs)
Also with the investment property you would be able to claim the negative gearing each year on the property (probably save yourself a few grand of tax each year).
Convincing your banker
It might be a bit harder convincing your banker on this idea.
The drawbacks to this more risky idea
1. You can’t make repayments and have to sell out early
2. You end up worse off (although at 3.25% you end up better off.. and some people say that real estate can go up up to 7% a year)
Other investments rather than property
This also works a bit with shares – but it doesn’t work as well because you don’t get the same leverage as shares. Also with shares there is the risk of trading in and out (for example if you thought the market was still going down and sold in Feb – you would have missed the large growth in the sharemarket since March 2009.