Should I Smash My Mortgage or Invest?

us3rnam3tak3n on 31/01/2024 - 16:57
Last edited 01/02/2024 - 00:28

I'm looking to the collective OzB wisdom for some input on a financial decision.

Before purchasing my PPOR I liquidated other investments. My focus was to minimise total interest paid and now my honeymoon rate is about to expire. Assuming 6% interest, balance approx 270k, it will be finalised in about 7 years at the current rate of repayment.

Now I'm considering the possibility of renting it out in 4-5 years to buy another PPOR. If I reduce repayments to the minimum and stretch the loan over 12 years I could free up about 15k pa to invest in ETFs (or similar) while I live there in order to build a new deposit. Possibly refinance into an interest only loan, I don't know. Similar properties rent in the 500-700pw range.

I'm open to other low-moderate risk strategies (no crypto bros) or for anyone to poke holes in my rough plan above. The timeframe is somewhat flexible. I live in WA so properties I'm considering are in the 500-700k range - guessing that could inflate to 800-1,100k in 5 years? My marginal tax rate is 37%. With a little discipline I could save/invest another 28k pa (on top of the 15k from reduced repayments). I could also put all of that towards smashing my mortgage in the next 4 years which doesn't seem like a very tax wise strategy but may have other benefits? My current savings is only 6 months of rainy-day expenses (Barefoot Mojo) with most other spare cash going into home improvements, holidays, gym membership and dining out. I'm allergic to bikies.

Thanks in advance.

Edit:
Thanks everyone for your comments. Some food for thought and genuinely good insight. I have a few months to consider, consult, calculate and implement a plan.

Financial Home Loan

Comments

  • Daniel Plainview on 31/01/2024 - 17:04
    +37

    If you're having to ask this, I say keep simple and pay off your mortgage - as if you had the investing chops to outperform the mortage, you'd in my opinion not be courting the opinion of 'all care, zero responsibility' strangers on a bargain forum.

    • us3rnam3tak3n on 31/01/2024 - 17:38

      Well I didn't have to ask but thought it might produce some helpful pointers. Your point stands though - a quick look at my ETF/stocks records during covid reveal I was only making around 5.5%pa gains on limited knowledge.

      • Daniel Plainview on 01/02/2024 - 07:48
        +3

        I understand where you're coming from - but I think while the lure of chasing high returns is present, there's a lot to be said for sticking with a known return and chasing your returns in other areas. i.e make sure your super is in the correct fund & asset allocations for your age, max out those concessional contributions.

        Having your super in exlusively intl & aus shares will balance with you owning your PPOR.

        FWIW this is the investing video I by far recommend most to folks - and it's not on tricks or approaches but rather how investors should try and assess whatever it is they've been doing - as 90% of folks INCORRECTLY associate profits with good practice/plans - which is completely irrational i.e toss dart at AFR on board, pick share it hits, buy and it goes up heaps, is that good practice?
        https://youtu.be/I8gH5bR3clg?si=LuHESQHoCR2-W65F

        All Ben Felix's videos are excellent - and I highly recommend. Also read this website from front to back.
        https://passiveinvestingaustralia.com/
        Both Felix and this guy (who is Aussie and posts on WP helping folks) have no services to sell or agendas. Best of luck :-)

        • us3rnam3tak3n on 01/02/2024 - 10:29
          +1

          That's some great input Daniel. I really appreciate it.

      • 911r on 01/02/2024 - 10:53

        If I can find the article again I'll share but it said something along the lines of while you can compare the mortgage rate vs investment returns it doesn't really take into account the compounding nature of the investment return. So that quickly starts to outperform after year 1. Something to think about.

        • us3rnam3tak3n on 01/02/2024 - 11:36

          Thanks, I do intend to invest for the longer term as well.

    • markathome on 31/01/2024 - 20:30
      +2

      Hey Daniel!

      We're multi-talented here: financial advice, legal advice, life coaching, relationship advice and yes…occasionally even bargains.

      We do it all! We're that good.

      • us3rnam3tak3n on 01/02/2024 - 00:29
        +9

        OzJim's

      • SlickMick on 01/02/2024 - 10:18

        I agree. I know I'm a specialist in my field, and count on finding the same in fields where I lack knowledge.

        It's just a matter of picking the specialist advice from the red herrings.

    • elgrande on 31/01/2024 - 21:57
      +3

      I think your taking a rather plainview of our collective abilities, Daniel.

  • freefall101 on 31/01/2024 - 17:20
    +12

    Interest on house - 6%
    Required earnings on ETF to be better off after tax - ~9.5%

    Sadly, the best returning ETFs the past year have been crypto ones. Go figure.

    If anyone can guarantee a 10% return with low risk, then go for it. Although it's probably a scam. But otherwise your earnings get taxed, your reductions in interest on your house don't, so you're better off paying off debt.

    Do you have an offset? I'd just load up cash into that until the balance is down to zero then look at what you want to do.

    • us3rnam3tak3n on 31/01/2024 - 17:45

      No offset on my current mortgage account but I'll consider adding one.

      • garetz on 31/01/2024 - 17:57
        -3

        You cant just add an offset to a mortgage, it changes the fundamental aspect of the loan, you would have to get a new mortgage.

        Which probably isn't worth doing with rates being what they are.

        • hasher22 on 31/01/2024 - 18:25
          +4

          You can definitely add and link an offset account to a mortgage. Depending on the mortgage that is.

          I know banks that don't add an offset to fixed rate until the fix rate ends but you can add one later on just depends on the banks policies.

        • us3rnam3tak3n on 31/01/2024 - 18:55

          Yeah, happy to refinance if it works favourably.

          • SlickMick on 01/02/2024 - 10:34

            @us3rnam3tak3n: You don't need to stop paying off your mortgage to accumulate a deposit IF you're happy to use the equity in your PPOR as your deposit.
            I refinance to do that. If valuation is $500K, and you have $270K to pay out previous loan, you'll have $230K sitting in offset account ready to invest.

            Whether an investment property is the best investment to make with it is debateable. That would be sufficient deposit for 2 properties. Maybe 1 property & 1/2 to shares??

            If you're a long-term strategist (and if you're not, future you will hate you), you should consider whether investments are better in your own name or in super.

    • watwatwat on 31/01/2024 - 21:02
      +4

      Required earnings on ETF to be better off after tax - ~9.5%

      Not really. Interest can be a tax deduction and unrealised gain is zero tax.

      10% return with low risk, then go for it. Although it's probably a scam.

      Well there is this thing called the S&P500…………

      • us3rnam3tak3n on 01/02/2024 - 00:22

        S&P500

        I used to hold some IVV on the ASX but iirc they didn't perform particularly well.

        Interest can be a tax deduction and unrealised gain is zero tax.

        In the scenario I posted above my intention was to realise the gain after 4-5 years. With further thought and consideration of the feedback here it has become apparent that I would create a significant tax bill in that year which would likely be greater than the deductions in the preceding years.

        I still appreciate your insight.

        • watwatwat on 01/02/2024 - 11:40

          I used to hold some IVV on the ASX but iirc they didn't perform particularly well.

          What on Earth. Look up a long term graph and it's a graph pointing constantly up to the right.

      • spurf on 01/02/2024 - 08:11

        Interest on your PPOR is not tax deductible

        • 911r on 01/02/2024 - 10:56
          +1

          It can be if you debt recycle.

      • SlickMick on 01/02/2024 - 10:20

        I wouldn't consider S&P500 low risk of not achieving 10% over 4-5 years.

  • try2bhelpful on 31/01/2024 - 17:20
    +1

    My suggestion is go talk to an investment adviser. They should take you through your risk appetite and investments that suit you.

    • us3rnam3tak3n on 31/01/2024 - 17:51

      I've always shied away from paying for advice but I guess it's okay to pay upfront if they're not taking a percentage.

      • try2bhelpful on 31/01/2024 - 19:35
        +1

        We had a brilliant accountant, unfortunately since retired, who we paid a fee to discuss our financial position a few times a year. They weren’t all winners but we did well over the years. The trick is finding the good financial advisor.

        When we were young it was a no brainer to pay off the mortgage, but interest rates were high and house prices lower than now. The idea was to eat into the principal as quickly as possible. We also had a mortgage offset account too.

        We just liked the security of a paid off house. Then we could invest with more confidence.

        Best of luck.

        • soan papdi on 31/01/2024 - 22:02

          What paperwork does the bank return when you close off a loan?

          • try2bhelpful on 31/01/2024 - 22:08

            @soan papdi: Been a while. Can’t really remember. Others might be better to answer.

          • SlickMick on 01/02/2024 - 10:25

            @soan papdi: Depends. We didn't pay the fee, so we got nothing.

            If you pay the fee, they give you the title.

            I'm counting on not needing that piece of paper in the future, so maybe I'll never have to pay that fee. But more likely, the bank still owns the property.
            I probably should look into that. (My wife had the conversation with the bank, so I don't know exactly what this fee is.)

            • soan papdi on 01/02/2024 - 10:26

              @SlickMick:

              If you pay the fee, they give you the title.

              I pay the mortgage and pay again to get the title?

              • SlickMick on 01/02/2024 - 10:48
                +1

                @soan papdi: Yes, at least with some banks - I think it's what they call a discharge fee. They want $500 for them to get the title out of their safe and post it to me (if that's how it still works, which would surprise me. I'd say they just print off a new copy from titles office without their mortgage on it??)

                Apparently the bank couldn't care less whether we pay or not for now. I suspect they'll ask for it at the end of the loan term, and then do whatever this discharge involves.

        • us3rnam3tak3n on 01/02/2024 - 00:01

          Thanks again. Might be time to bite that bullet.

        • Woody982 on 01/02/2024 - 09:45

          So what's the point of an offset mortgage, if you can just put it on the loan and redraw any of it that you need anyway?

          • us3rnam3tak3n on 01/02/2024 - 10:47

            @Woody982: Well in my case it would have the benefit of reducing the interest I'm paying on the current PPOR (effectively gaining 6%, tax free) and when I'm ready to buy again I can empty the account into a new property. This would drive up the interest paid on the first loan but as a rental it would then be tax deductible.

            edit: oh, you mean offset vs redraw. I guess it's just less restrictive - the bank can't say no.

            • Woody982 on 01/02/2024 - 11:54
              +1

              @us3rnam3tak3n: Hmm ok, never had an issue redrawing. I just do it in the app. Can't remember if it's instand or takes a day or too though. (I'm with Commbank for home loans and normal banking is with NAB)

        • mrtin on 07/02/2024 - 22:18

          Accountant advised on shares?

  • Drakesy on 31/01/2024 - 17:22
    +4

    If your investment is making <9% then your offset is the answer.

    • djkelly69 on 31/01/2024 - 17:38
      +5

      Also offset is zero risk (in that there is no chance you don't save 6% or whatever your home loan interest rate is, tax free), whereas basically all investments offering >9% return will be nowhere near zero risk.

      • us3rnam3tak3n on 31/01/2024 - 17:52

        Offset making more and more sense.

    • us3rnam3tak3n on 31/01/2024 - 17:52

      Yep, makes sense.

  • 2jzzzz on 31/01/2024 - 17:23
    +6

    If you are definitely going to buy another PPOR, you want the current place to have the most debt to be tax deductible when you rent it out. This means you could just build up the offset account rather than paying it down (in essence does the same thing) then pull all the cash out and move it to new PPOR mortgage.

    I'm no pro, but have a listen to The Property Couch on how to structure. Could even go Interest Only to free up the extra cash to offset a

    • us3rnam3tak3n on 31/01/2024 - 17:52

      Thanks, I'll check them out.

    • cooni on 31/01/2024 - 18:30
      +2

      This is the best advice here if you're looking to change your PPOR to an IP.

    • larndis on 01/02/2024 - 08:04

      This! Very important to understand the tax implications of converting your PPOR to an IP. Do not reduce your current loan by a cent more than you need to.

  • bobbified on 31/01/2024 - 17:31
    +1

    You have to out-earn whatever the interest on your mortgage after paying tax on your marginal rate on any investment income. And if the final return is anything similar to the mortgage interest, then it's still better off in the mortgage because there's no investment risk there.

    • us3rnam3tak3n on 31/01/2024 - 17:52

      I'm starting to see a theme in these comments.

  • Aussiebargainer on 31/01/2024 - 17:49

    Invest. Leverage is key to wealth creation

    • us3rnam3tak3n on 31/01/2024 - 18:57

      Hmm, I don't think I want debt for investing at this point.

  • Jaduqimon on 31/01/2024 - 18:01
    +4

    Why is everyone saying equivalent etf 9%? If your holding long term there's cgt discount. So equivalent will be closer to 7.5%.

    • us3rnam3tak3n on 31/01/2024 - 18:53

      True, I would be looking to hold for 4-5 years so all but the last 12 months is 50% CGT discount. However, if I sold all in the same tax year my marginal rate would likely hit 45% for a fair proportion.

      This is why I asked for input - so many factors to consider.

    • zorodluffy on 31/01/2024 - 19:54

      This.

  • hasher22 on 31/01/2024 - 18:27

    Looking what you said vs risks and the percentages now.

    You're looking an dumping in an offset.

    Go talk to your bank and ask for and link an offset account

    • us3rnam3tak3n on 31/01/2024 - 19:16

      This seems to be the sensible consensus. Once my honeymoon rate expires I'll pursue my options.

  • AustriaBargain on 31/01/2024 - 19:33
    +5

    Warren Buffet would say invest. But he can afford to gamble. A humble life where you own your own home, have some spending money from your income, and have retirement secure with super and can at least fall back on the pension sounds pretty good to me. If you can pay off your home in seven years then you could invest later still.

  • Lunarboogie on 31/01/2024 - 19:52
    +1

    Depending on your age, I'd also consider maxing out your concessional super contributions, including catch up contributions. I'd even put this strategy ahead of the offset because it is tax free after 60 when means you only have to beat 6 per cent each year which is easily achievable according to the 10 and 20 year average returns for the growth options with many of the major firms.

    • zorodluffy on 31/01/2024 - 19:54

      This.

      • zorodluffy on 31/01/2024 - 19:55

        Also go with passive index high growth, or AUS and INT shares (if you are young).

        Dont go with the managed high growth options etc (basically 1% p.a fee vs 0.2%ish)

        • us3rnam3tak3n on 01/02/2024 - 00:09

          It's been about 5 years since I adjusted my super mix. Probably a good time now to reassess it.

    • us3rnam3tak3n on 31/01/2024 - 21:44

      Thanks, I'll definitely run some calculations on those scenarios.

  • th123 on 31/01/2024 - 20:35
    +1

    split it
    invest some, pay some off, be in neither the best or worse scenario

    • us3rnam3tak3n on 01/02/2024 - 00:03

      Yeah, I plan to pick up some investments regardless of the housing situation.

  • Mechz on 31/01/2024 - 20:51

    You mention building another deposit, have you ever heard the term 'equity'?

    Maybe put that on your research list.

    • us3rnam3tak3n on 31/01/2024 - 23:09

      The equity in my PPOR? Meaning to use it as security?

      • Mechz on 31/01/2024 - 23:40
        +1

        Yes, this is why people with houses mostly paid off get finance so easy.

  • JIMB0 on 31/01/2024 - 21:37
    +5

    Having a paid off home is a wonderful thing that opens up so many options. You can take on more risk as your need for a regular reliable income is much less.

    • us3rnam3tak3n on 01/02/2024 - 00:07

      I generally agree with this but sometimes it pays to explore options with some tax benefits.

  • DingoBilly on 01/02/2024 - 07:14
    +1

    I was in a similar situation and split it myself.

    33% went into offset and 66% was invested. The sums were a fair bit higher though, if it was the difference between $15k and $10k like yourself I'd probably just put it all into an offset.

  • Mugsy on 01/02/2024 - 07:34
    +1

    At the current interest rates i would go with offset account and throw as much money into it as i can.

  • Rob-4x4 on 01/02/2024 - 08:09
    +1

    I did both. I over paid my Mortgage by paying at a rate above what the interest rate could go to, I choose 10 percent. (I had seen 17 percent interest rates earlier). Also it meant my weekly budget was set to handle high interest rates if they happened again.

    Also through work there was a share purchase plan were I could purchase shares at a discount, and I joined it as well.

    So when value of shares (Taking into account tax liability ) was greater than outstanding mortgage, I sold shares and paid off mortgage (That was a good day :) )

    It was challenging and I lived frugally (No O/S or big holidays etc) but worth it as with retirement getting close I own my own home and have decent super investments.

    Other tip is I have always purchased homes that I knew I could afford, not what the banks told me I could afford…. I am a big fan of buying the worst house in the best street…The three rules of real-estate … location-location-location as some people say.

    • us3rnam3tak3n on 01/02/2024 - 11:16

      Yeah, I'm currently paying at the equivalent of 14.75% interest rate (max allowable on my fixed rate). I think I'll redraw the excess payments and put into an offset account when the honeymoon rate expires and continue to put extra into that. I believe I have time to complete my PPOR purchase plus one more property before retiring, while also squirelling some investments away.

      My work also has a lucrative share purchase plan but I'll need to become staff (currently contracting to them) to become eligible. I'll bring it up with the boss at my next review.

      I have always purchased homes that I knew I could afford, not what the banks told me I could afford… location-location-location

      100% agree

  • 82norm on 01/02/2024 - 09:47
    +1

    Age, how’s your super looking 15% pre-tax? Depends if you need cash on hand too I guess.

    • us3rnam3tak3n on 01/02/2024 - 12:13

      Obvious tax benefits. I need to do some forecast calculations to work out whether this is feasible while still paying off the properties and investing.

  • Hector on 01/02/2024 - 11:52

    Sounds like an offset account would be useful, as those returns are post-tax vs pre-tax (i.e., if you're in the top tax bracket, a 6% home-loan offset is the equivalent of 12% pre-tax returns). Virtually risk free.

    One thing to check - does the offset account KEEP the offset savings (Tictoc), or allows you to take it out (AMP, ANZ), which may be important if you need the cashflow

    • us3rnam3tak3n on 01/02/2024 - 12:17

      Yes, I'll definitely need cashflow when I convert the PPOR to IP and take on a new PPOR.

      does the offset account KEEP the offset savings

      I'll read up on my T&Cs

    • banaltheory on 06/02/2024 - 00:51

      Hector, can you explain what you mean by "keeping" the offset "savings" vs allowing you to take it out? Afaik tictoc allowed money to be taken out of offset account.

      As for OP, get an offset account, then put the money in there for now, then take it out for your next PPOR.

      • Hector on 06/02/2024 - 06:09

        Your home loan payments are fixed at the interest rate you have. The home loan pays your interest first,’and anything above that is for principal.

        • For example: if your loan payment was 10k, and interest was 4k, 6k was applied to principal.

        If, in an offset account, you carry a balance, the payment is the same, the interest you pay is lower, so what happens with the interest you’ve “avoided” because of the offset benefit.

        • So with an offset balance, the $10k payment with $2.5k interest puts $7.5k to principal.

        What can you do with the $1.5k?

        . At Tictoc, it’s applied to the home loan balance, and you can’t redraw/take it out. It’s still your money, just a lower loan balance owing.
        . At AMP or ANZ, you could keep applied to principal, take it out into the offset, or withdraw the surplus.

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