It’s been a long-held Australian tradition that the mortgages on our homes must be paid off sooner rather than later.
I’m sure you remember your parents scrimping and saving so they could own the roof over their heads before they retired.
But is it a sound strategy to pay off your mortgage faster?
Good debt, bad debt and tolerable debt
When it comes to debt, there are three types – good, bad, and necessary.
Good debt is the mortgages we have on our investment properties because we’ve invested in assets which grow in value over time and which we’ve financed by using other people’s money – the banks!
Investment mortgages are also tax deductible so it’s a double win really.
Bad debt is anything you buy on credit which ends up costing you much more than the original purchase price because you’re paying interest and the doo dad you bought has gone down in value.
Necessary debt for many people is the mortgage they have on their home because we accept it finances the place where we live and spend the majority of our lifetime.
The thing is, the mortgage on your home is not tax deductible, but paying it down does reduce the amount of interest you will have to pay over the life of the loan.
And, in reality, your home is an asset that increases in value over time.
The equity equation
Many people believe that if they pay down their home mortgages then they’ll be able to access the equity to invest, but there is a big problem with this.
The issue is: to access any equity in your home you will need to ask the bank for permission to use your own money.
Before granting consent they will value your home, which depending on the market cycle could be a favourable result or could be a figure that’s much less than you hoped.
It’s an unfortunate fact that today many valuations are below true market value – unless of course you’ve access to professional advice on how to improve your valuation.
So let’s say through hard work, sweat and tears you have reduced your mortgage by $100,000 and are ready to invest in another property.
You go to the bank, cap in hand, to get some of your own money back, but the valuation comes in low which can effectively negate much of the hard work you’ve done making your repayments.
Another consideration is that if you pay off $100,000 – even if you receive a favourable valuation – you’ll only ever be able to access 80 per cent of it as banks generally like to keep to a 80/20 loan to value ratio.
As you can see, paying off your mortgage in the hope that one day in the future you’ll be able withdraw it again, isn’t always the best idea.
But there is a better way….
Many successful investors opt to use an offset account instead.
An offset account allows you to save your spare funds into a separate account that is linked to your loan account and that will “offset” the balance of your mortgage when interest is calculated every month, thus reducing the loan amount that interest is paid on.
In other words, you only pay interest on the net balance of the two accounts.
And the tax department doesn’t see the notional interest earned in your offset account as taxable income.
So the question is…
Who would you rather have control over your cash?
By using an “interest only” loan and depositing your hard earned principal payments into an offset account, you still have full control over those funds.
Your dollars are in your control, not in the hands of the bank and not subject to the opinion of a valuer – who is, after all, acting under the instruction of the bank.
The main point here is by building up your savings in your offset account you can access those funds whenever you want.
You don’t have to grovel to the bank to allow you to get your money back.
Instead, the power remains completely with you – and that is the optimal situation for all investors.
So, what you rather do?
Hand your money over to the bank or use it for your next investment property when the timing is right for you?