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Archives for September 2019

Should I invest or pay off my home loan?

It is a common dilemma for Australians all over the country. Do you use spare money to pay off your mortgage and reduce debt? Or do you invest it somewhere else in the hope of boosting returns and improving your overall net worth?

Making a decision based on numbers alone is relatively straightforward (I’ll show you this soon). However, it is not that simple. For all of us, there are other considerations that come into play, including our emotional response to money and security. Let’s take a look.

If there were a simple answer, it would be this.

It may be worth investing if the ‘after-tax return’ you get on your investment is greater than the interest rate on your mortgage.

Let’s say, for example, that the interest rate on your mortgage is 5 per cent, with your investment returns 7 per cent at after tax and other costs. Financially, you are 2 per cent ahead. You could reinvest this money or even use it to pay down your mortgage – helping you achieve both goals.

Of course, this approach depends on your personal income and the marginal tax rate you pay. In the table below, you can see how much investment return you need for this strategy to make sense. If, for example, you earn the average Australian full-time income of $81,530 (with a marginal tax rate of 32.5 per cent), you need 7.4 per cent pre-tax from investment to achieve an after-tax return of 5 per cent.

Can you see what this table shows us? The higher your income, the more you need to make on your investments in order for this strategy to work.

There are other things you need to consider such as the impact of variable interest rates and the actual return of the investment. But it does give you a general idea of where your money might be better off.

Some other reasons people choose to invest their money instead of paying off their mortgage include diversification and accessibility.

Some people worry about having all their money tied up in their home. What happens if prices fall dramatically? We can’t predict the property market but diversifying investments can offer some protection.

Another consideration is accessibility. You need a lot of money to buy a property. Investing in shares or managed funds, on the other hand, requires much smaller amounts. It’s also generally easier to get your money out when you need it.

Reasons you might pay off your mortgage instead of investing

· Peace of mind: The emotional aspect of investing is just as important as the numbers. If your number one goal is the security that comes from owning the roof over your head, then that’s what you should do.

· Pay less interest while getting a guaranteed return: Additional money you pay into your mortgage reduces the interest you’ll need to pay and the duration of the loan. Plus, it acts as a guaranteed return. If the interest rate is 5 per cent, you’re effectively getting a guaranteed 5 per cent return on any extra money you add to your mortgage.

· Build equity: The more you pay off your loan, the more equity you have in your home. Coupled with capital growth over the long term, you can borrow against this equity in your home to build a larger property portfolio.

At the end of the day, we all want to sleep easy at night. For some of us that means feeling comfortable with our financial decisions. If your focus is debt reduction, then go with paying down your mortgage. On the other hand, if your goal is long-term wealth creation and the numbers stack up, then look to invest your money at an appropriate level of risk.

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Australia’s Household Debt

Australia’s household debt to income ratio is currently at 190% which is among the highest in the world. This number is a far cry from the debt to income ratio from nearly 30 years ago which stood at around 56%. The rapid increase of household debts can be attributed to a rise in mortgage debt which has been brought on by Australian’s looking to purchase their own home or investment property. Other reasons as to why we have seen a sharp increase in the debt to income ratio is that over the last decade we have been given easier access to credit, built a reliance on credit cards and experienced lower mortgage interest rates.

Facts About Australia’s Debt to Income Crisis

The recent property market boom has resulted in many Australians borrowing higher amounts with wage growth not keeping up with rising housing and living costs.

  • Lower interest rates have been a key factor in growing debt. When credit is offered at a lower rate, borrowers want more of it.
  • Whilst some developed countries have seen a decrease of debt to income ratios since the Global Financial Crisis, Australia’s debt levels have increased to record levels.
  • The Reserve Bank of Australia is carefully monitoring the levels of residential lending, and the risks associated with high household debt. Further cash rate cuts may be required as the outlook for household consumption has slowed.

Managing Your Debt

If you are having difficulties managing your debt, here’s a few tips to keep in mind:

  • If you have multiple credit cards and other personal loans, you should consider consolidating your debts into one loan account. If you have equity in your home, you could consider refinancing the debts at a reduced interest rate.
  • Create a budget and have the discipline to stick to it.
  • Set up a savings account and try to contribute any surplus from your budget for upcoming expenses. This may assist you to avoid using a credit card or drawing down on other loans to cover expenses.
  • Resist the urge to splurge on credit cards!

Please contact us today for a confidential, cost and obligation free discussion about your lending needs.  We would also be happy for you to refer your family or friends so we can assist them in creating a cost-effective home loan which suits their needs.

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