The Golden Rule

Pay off your home loan before you invest

Is this a rule that is meant to be broken? It certainly deserves a closer look.

Property investors often refer to either good debt or bad debt, where good debt is for investment (and is tax-deductible) and bad debt is personal debt (and is not). So it makes sense to pay off your personal debt before you invest, doesn’t it?

Before you can answer that question, you need to ask yourself a different question. Is this a personal decision or a financial one? If you make a personal decision not to invest until you are debt free, then that is your choice. But don’t kid yourself that it is always the right financial decision.

Let me explain. Clients Chris and Kylie Jackman have a $250,000 mortgage and have the chance to buy a $400,000 investment property that is negatively geared $50 a week. They think about it overnight and understandably are nervous as it is their first investment property.

After looking at properties for months it is crunch time: they need to decide. They discuss it again that night and get more and more nervous. It’s like they are looking for a reason not to decide. Then Chris says “You know what? I think it’s better if we pay off our mortgage first. That $50 a week would make a big difference.” Kylie quickly agrees and they both sit back happy that they found a legitimate excuse not to invest.

But is the excuse legitimate? I suggest not!

Let’s say the Jackmans are making the minimum payment on their mortgage. At 6.5% interest they will pay the bank $568,000 over 30 years. If they put the $50 a week towards paying down their mortgage instead of investing, they reduce their home loan to 21 years and save $103,000 in repayments. Is that a good result?

Yes, but what happens if they buy an investment property instead? Let’s say they have to contribute $50 every week for the same 21-year period – the results are telling.

At 6% capital growth Chris and Kylie would make a capital gain of $960,000. This result puts them ahead of their debt reduction strategy by $857,000.

What about if the Jackmans already pay extra onto their mortgage – perhaps $150 a week? That would mean they are on track to be debt free in about 16 years and save $183,000 in interest.

Reducing their extra payment to just $100 a week means they won’t be debt free for 19 years and they will save $153,000 interest to the bank (so they are paying $30,000 more to the bank in this scenario than if they were still paying the full $150 each week). However if they buy the investment property instead, over the same 16 years they could make a capital gain of $616,000.

Paying off personal debt first is not as clear cut as it may seem. The best thing to do is use the excellent mortgage calculators on our site or the API website and run the figures for yourself.