By Brett Warren August 11, 2020

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Should you pay off your home loan before you invest?

Property Investment
Should you pay off your home loan before you invest?

Paying off your home loan sounds like a great idea.

So does investing for your future. If you don’t have enough money to do both – and a lot of people don’t – which do you go for?

Most people are actively paying off both the principal and the interest, because that’s what they’ve always done.

But is that the best way forward for your investment property strategy?

Meet would-be investors Joanne and Richard (names changed for privacy).

They have had a home loan for three years and have decided to look into property investment.

Joanne has been told that because their home loan is ‘bad debt’, it’s best to pay it off first and create a bigger margin in their income, before taking out loans for other properties.

However, Richard thinks it would be best to pay interest only on their home loan, and use the amount they would have paid as principal towards some investment properties.

Who’s in the right here?

We’ll get to that in a moment…

First, clients often tell me that their financial advisors counselled them to pay off their own loan first before investing in property.

It’s true that home loans are a debt we want to get rid of - but I call this necessary debt - not bad debt.

And drip-feeding cash into your loan each week is a laboriously slow way of paying it off, and takes a large amount of your working life to get there.

Let’s look at Joanne and Richard’s situation and compare their options.

They have a 30-year home loan and are paying off the principal at an average of $10,000 a year.

This means in ten years, accounting for a little compounding, they will have paid somewhere in the vicinity of $120,000-$150,000 off their loan.

Eventually they’ll pay it off, but it’s a very slow method to getting there.

Option two paints a very different picture.

Let’s say they borrowed some money (using the equity in their home as a deposit) and bought an investment property for $500,000, which increased in value over ten years to become worth $1 million.

In 10 years, they’ve made $500,000 profit (at a growth rate of just over 7%).

So in the first scenario, they have paid, at most, $150,000 into their home loan.

In the second, they are $500,000 ahead because they used their money to service a loan for their investment rather than to pay down their home loan.

The end result?

Even if they didn’t invest in any other properties, they are far ahead and even though they still have a home loan - with inflation their loan is not as big a burden, and with the appreciation of the value of their home it's a much smaller percentage of its value.

In other words their loan to value ratio would be much lower and manageable.

Of course they could always sell the investment to pay off their own home mortgage in full, but that's a bit like killing the goose that lays the golden eggs.

The short story is, if Richard and Joanne wait to buy a property until their own home loan is paid, they are missing out on three decades worth of future capital growth in a property they could have invested in.

That is why when people ask, “When’s the best time to invest in property?” my answer is always: as soon as you can!

Property investment is about the long-term.

It’s not about immediate wealth, and it’s not a get-rich-quick scheme.

As I said, sure paying off your home loan is an admirable goal, but it’s a very slow process.

It’s a bit like putting a little cash into a savings account each week.

Yes, it’s a strategy to earn interest, but there are far better and more profitable ways to manage your money.

Many Australians are still paying off home loans long after retirement, which is never an idyllic way to spend your hard-earned twilight years.

The ideal way forward is to plan to pay off your home loan as soon as possible, but don’t do it at the expense of greater wealth in the long run.

You want to be buying a speedboat at 65, not funneling your retirement money into your mortgage!

Let’s take our couple’s situation to another level

Imagine if they invested in several properties over the years, using the increased equity in their investment property and their home to qualify for more loans.

As their properties increase in value, they may even sell down and pay off their home loan in 10 years.

They now have even more margin in their budget to buy more properties.

In their home loan time frame of 30 years, they now have a property portfolio of $3.5 million and they own their own home outright.

Or, if they chose to pay off their home loan first, they have simply paid off their home loan and 30 year’s worth of interest, and have only just begun to invest in properties at age 55.

Whatever advice you’ve heard, take the time to research and properly investigate the best course of action for you and your personal situation.

Remember, if you wait 10 years to invest in property, you may miss a whole cycle of capital growth.

This will not only impact your bank balance, but will rob you of an opportunity to increase your asset base and work towards a financially healthy retirement.

But there's one big proviso...

These recommendations are based on the assumption that you buy "investment grade" properties - ones that exhibit superior capital growth.

Now is the time to take action and set yourself for the opportunities that will present themselves as the market moves on.

If you're wondering what will happen to property in 2020–2021 you are not alone.

You can trust the team at Metropole to provide you with direction, guidance and results.

In challenging times like we are currently experiencing you need an advisor who takes a holistic approach to your wealth creation and that's what you exactly what you get from the multi award winning team at Metropole.

If you're looking at buying your next home or investment property here's 4 ways we can help you:

Strategic property advice. - Allow us to build a Strategic Property Plan for you and your family. Planning is bringing the future into the present so you can do something about it now! This will give you direction, results and more certainty. Click here to learn more
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About Brett Warren Brett Warren is National Director of Metropole Properties and uses his two decades of property investment experience to advise clients how to grow, protect and pass on their wealth through strategic property advice.

3 comments

Alex 2016-08-09 20:06:08

People pay principal because owning your home is more than investment in a house, let alone special treatment of own residence by Law. Emotions aside, paying interest only on one's own residence puts it in an awkward position between residential inve ...Read full version

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Damien 2015-11-21 14:13:24

1 reply

Would you like to share your thoughts?

Alex August 9, 2016

People pay principal because owning your home is more than investment in a house, let alone special treatment of own residence by Law. Emotions aside, paying interest only on one’s own residence puts it in an awkward position between residential investment and home. Let’s face it, the requirements to my home are different to requirements of my investment properties. I live where I want my family to live. My own place is not always where the capital growth is maximal and I choose my own house not merely by where I can accelerate capital growth… From pure $$ perspective, unless you live in an investment grade property, why ever buying own residence, even by paying interest only?? For maximal $$ efficiency one needs to own only investment grade properties in selected capitals and rent elsewhere. But then, eventually it comes to dilemma whether you (and your family) live in places and in properties to make money or, vice versa, you make money to live where you want and how you want..

0 replies Reply

Damien November 21, 2015

There are some big assumptions in this article. First of all there is an assumption that the property being purchased will grow at approximately 7.2% p.a. in order to double in value in 10 years. Tell that to investors in Perth that purchased property in 2007 – the median gain in Perth in 8 years has been approximately 20% in total. Won’t go close to doubling in value in that 10 year period.

There is also no mention of the high transaction costs associated with property. For example what is the stamp duty going to be on a $500,000 property? Agent commission on the sale?

Even if your property doubles in value in 10 years, the only way the “profit” would be $500,000 using your example would be if the investor was completely neutrally geared. This would have to assume a new property where the investor is taking advantage of depreciation. Even so, it is a big ask for a, presumably new, $500,000 property today to be double its value in 10 years. Take a look at the suburbs around Australia where you would buy this kind of property and tell me it will double in value in 10 years.

Unless you sell the investment property to reduce your principal residence mortgage and therefore incur Capital Gains Tax, you have not done anything to reduce your principal residence mortgage and given that you reduced your payments you have not paid down as much of your mortgage as you could have.

An independent advice article should also look at other options with surplus cash such as salary sacrificing into superannuation and looking at the compounding effects of this strategy over time.

1 reply Reply

Kate Cull November 24, 2015

Thank you for your response. You are quite correct that there are a lot of assumptions in there. The biggest being covered by the proviso at the end of the article “These recommendations are based on the assumption that you buy “investment grade” properties – ones that exhibit superior capital growth”. So you have hit the nail on the head when questioning the capital growth needed to make these strategies work. Melbourne’s average growth rate over the last 10 years has been 7.1%, with correctly selected investment grade properties performing significantly better.
In identifying what constitutes an investment grade property we use Michaels “top-down” and 5-stranded strategic approach. After examining Michaels approach on how to go about selecting a property that will outperform on a capital growth basis you will understand why we haven’t bought in Perth for clients for a number of years, and that we do not advocate buying new or off the plan (because of the premium built into these types of properties).
We agree that there are significant costs involved with property purchases, and indeed even more with selling. That is why, when added to the compounding effect you enjoy when holding onto a property, it makes sense to buy and hold (and then hold some more). It isn’t necessary to sell the i/p to release the equity in order to pay down the principle place of residence. This kills the goose that is laying the golden egg and it would be preferable to refinance the i/p (and retain the asset) and use the proceeds to pay down the PPOR mortgage.