If achieving homeownership is a financial milestone, then reaching mortgage-free status is the real estate holy grail.
With that said, many Australians also aspire to building a profitable property portfolio. But which comes first; paying off the home, or buying an investment?
Merimbula-based Mortgage Broker Jen Hughes says she guides her clients to consider all their options before making the decision.
“The best advice we can give as brokers is to get people to ask the right questions of the right people, in the right order,” she explains. “We can't make decisions for you, and a good broker shouldn’t be pressuring people to get into something that will cause them stress later.”
While it makes the choice more complex, Ms Hughes says that a one-size-fits-all answer to mortgage repayments versus property investing doesn’t exist.
“It depends on how many people are in the scenario, and how much they earn,” she says. “I encourage people to work closely with a trusted accountant, and maybe a financial planner to forecast it like a business plan.”
Envision Financial founder and financial planner Luke Smith tells Mortgage Choice that having a debt-free home and a property portfolio are not mutually exclusive.
“People need to understand the type of borrowing they're going to maintain,” he warns. “I always advocate where you have spare money, get rid of non-deductible debt as a priority and then get good debt against the same asset to try and further your wealth creation.”
Mr Smith says that while carrying debt is not wrong, it should be structured correctly for particular reasons.
“People find a lot of comfort in not owing a debt on their home, but that could also then be wonderful leverage for other opportunities done in a controlled manner,” he says.
Key considerations exist for Australians who are in contract or freelance work, which approximately 1.1 million people, according to the Australian Bureau of Statistics.
In that particular work situation, its crucial to fully understand the weight and conditions of any debt.
Experts agree understanding your debt is key to managing it. Picture: Getty
“It's a lot harder for people to borrow when they don't have that employee status in the eyes of a lender,” Mr Smith explains. “They are going to potentially need bigger deposits with different loan structures, and it might take a little longer to get into a market.”
While personalised advice on which investment strategy to take is vital to stress-free investing, there are general parameters for all to consider.
“I find a neutrally geared asset is far more resilient during times of uncertainty and it also takes the pressure off the family unit,” Mr Smith says. “If you're heavily leveraged with a negatively geared investment property, then you’ve got the obligation to remain in the workforce, keep the job you may not like, because you have created this machine you need to feed.”
With a wealth of information at hand and with the inflationary environment finally beginning to cool, Ms Hughes said people are becoming more calculated with their financial decisions.
“[People] are considering their best case scenario, as well as their worst case scenario,” she says.
This includes what might happen if an investment property sits empty, if its value goes down, and whether money should still be spent on other forms of saving, such as additional superannuation contributions.
“What you can do and what you are willing to do is different for everyone,” Ms Hughes says. “Some of my clients might be approved to borrow up to $2 million, but they only feel comfortable getting $800,000.
“Everybody's risk tolerance is different. After all, you're the one who has to pay the mortgage.”
For those unsure of which path to take, Mr Smith says that trusted advice is paramount.
“Make an informed decision, whether that's an accountant, a mortgage broker, a planner, or somebody that can just help you avoid the comment ‘I wish I'd known…’ then you're going to be in a better position.”
“Getting clarity on all the information and really understanding what you’re getting into will help you answer that ‘should I? shouldn’t I?’ question in a lot of instances,” he adds. “Even if it means going back and saying ‘hey, I don't really get this, can you please explain that a bit more?’”
The case for paying off your mortgage
Below are several key benefits to paying off your home loan first.
Peace of mind
There is power in owning your home outright. For most Aussie households, a home loan is the biggest ongoing expense and often the greatest source of stress, especially when interest rates are high like they have been until very recently.
Clearing your home loan debt makes you less susceptible to market downturns. Picture: Getty
Save on interest
By paying off your mortgage earlier than anticipated, you are actually making money because you’re effectively earning a return equivalent to the interest rate on your loan. For example, if your mortgage interest rate is currently 6%, then every dollar you pay off early is like earning a 6% return after tax.
Reduced risk
When you clear your home loan debt, you are less exposed to market downturns, interest rate rises, and even tenant vacancies. It’s a great position to be in for anyone with a lower risk tolerance, in seasonal or freelance work, or heading into retirement.
If you're heading into retirement, your priorities around wealth accumulation may be different. Picture: Getty
The case for investing in real estate
Below are several key benefits to focusing on investing in property.
Improved borrowing position
Choosing to wipe out your mortgage now, rather than buying an investment property, doesn’t close the door to building a portfolio one day. Owning your home outright can strengthen your financial position when applying for loans in the future.
Leverage and capital growth potential
Instead of paying off your mortgage, you could leverage your home’s equity to buy an investment property. This strategy allows you to build wealth through the capital gains in an investment and potentially earn rental income at the same time.
Buying an investment property often helps accumulate more wealth in the long run. Picture: Getty
Taking advantage of tax
It’s a controversial strategy, but negative gearing (where rental losses can be claimed against other income) can help you lessen the burden of holding an investment property that isn’t making an immediate profit. You can also claim depreciation on fixtures and fittings, as well as potential capital gains discounts.
Enjoying a passive income stream
A well-considered investment property can generate passive income through rental returns. It’s taxable income that might supplement your current salary or provide much-needed cash flow during retirement.
Spreading the risk
By owning more than one property, whether it’s your home and just one investment property, you are reducing your risk across multiple assets. A diversified real estate portfolio could protect your future wealth in the future.
What to consider before making a decision
Here are several important factors to consider when you make a call on ether to invest first or pay off your home loan.
Your age and life stage
It’s clear that if you're approaching retirement, then the stability of being mortgage-free might outweigh the potential gains of investing. However, if you're in your 30s or 40s with some good equity building up and decades of earning power ahead of you, then using your home to invest could accelerate your wealth creation.
The interest rate ride
In a low-interest rate environment, the cost of not investing may be higher. But when interest rates are rising it might make more financial sense to reduce your mortgage faster, especially if your loan is variable.
Investment return and risk appetite
It’s comes with the turf – real estate investment involves risk. Your tenants may default, property values can fall, there might be unexpected maintenance issues or costly special levies on apartments.
If you consider yourself to be financially conservative, or already feel financially stretched, then paying off your mortgage may be the safer priority.
Creating a cash flow and buffer
Ask yourself if you have a strong enough buffer to absorb financial shocks like job loss, illness, or interest rate hikes. Having a fully offset mortgage, or at least emergency savings, is crucial before committing to another large financial obligation.
This article first appeared on Mortgage Choice and has been republished with permission.
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