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Why paying off your mortgage is not the best property investment strategy

  

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Did your parents ever tell you that the smartest way to build your wealth is to buy a home, and then pay all your surplus cash into the mortgage to pay it off as fast as possible? My parents certainly told me, and it is such a widely held belief that it has almost become common wisdom for parents to pass this financial advice to their children.

While we agree that it is certainly one way to build wealth, is it the best way?

To illustrate the difference, let’s take an average couple, John and Joan. They have a decent house in the suburbs, two children and a combined income of $120k. They have a comfortable life, nothing too fancy, just two ordinary working people.

John and Joan both want to retire at the age of 65. To have a comfortable retirement they think they will need to have the house paid off and income of about $50k a year (in today’s dollars, keeping in mind inflation).

John and Joan calculate that their living expenses are currently $50k pa. They still owe $300k on their mortgage and after their mortgage payments, living expenses and tax they have a surplus of $17,210 pa. If they pour the entire surplus into their mortgage and then into superannuation, they will pay their house off in nine years. Now that actually seems like a pretty reasonable thing to do, but is it?

How about this as an alternative: if John and Joan ask McCarthy Group to use the same numbers, and to develop a plan for them that is based on investment property using their existing property as leverage, their outlook would look very different.

How is it possible to create such a different outcome? How is it possible to reduce the tax payable? Does this saving on tax help to build the superior outcome? Here’s how it works.

Let’s say John and Joan build a brand new investment property through McCarthy Group. The new home costs $397,000[1] and they then rent it out for $390 per week[2]. With the tax deductions structured by McCarthy Group specialists, Joan and John manage to reduce their tax bill by $9,674! So with this ongoing tax reduction, and an additional sum from their own pocket, John and Joan have now purchased their own investment property.

In the first year of ownership, who is paying for John and Joan’s new house? Well the tenant pays a total of 58% of the mortgage; the taxman is contributing 29% to the mortgage (via the saving of $9,674), leaving John and Joan to find the other 13%. In dollar terms, they contribute $81 per week to own another house! 

So what does this mean for retirement? Well to generate an income of $50k pa in today’s dollars (bearing in mind inflation creeps up every year), John and Joan would need a lump sum of $2,093,778 in cash or assets to comfortably draw down $50k pa without diminishing their asset base.

If John and Joan don’t buy an investment property, and instead use their surplus to pay down their mortgage, and then contribute that same surplus to their superannuation fund, they will end up with $2,029,650. It’s just short of the amount needed for a comfortable retirement.

However – and here’s the good news – if they do go ahead and buy their investment property, their capital at retirement would be worth $3,431,129, an improvement of more than $1.4 million over 25 years!

How would you like to discover a strategy that can generate significantly more wealth for your retirement, using the same funds, compared to the age-old method of simply “paying down the mortgage”?

If you would like more information, download our Little Cash, Big Profits free guide to leveraging the equity in your own home or contact us for an obligation-free consultation.  In this consultation, McCarthy Group specialists will develop a financial strategy for you and calculate what your improved retirement scenario looks like.   It could change your financial future, contact us today.

Assumptions:

These figures have been calculated by Rod Ross, tax specialist within McCarthy Group. 
The assumptions used in the calculations are as follows:

Married couple, Both John and Joan are 40 years old, John’s salary is $100k pa, Joan’s salary is $20k pa, Current family home is valued at $600k, Current mortgage is $300k, Current living expenses are $50k pa, Total super balance at age 40 of $80k, Planned retirement age is 65, Annual inflation rate of 3% pa, Superannuation growth rate of 5% pa, Property value growth rate of 6% pa, Interest rate of 7% pa.