Buy LICs or pay down mortgage?

Discussion in 'Share Investing Strategies, Theories & Education' started by itsmescottyc, 18th Feb, 2019.

Join Australia's most dynamic and respected property investment community
  1. itsmescottyc

    itsmescottyc Well-Known Member

    Joined:
    5th Jan, 2017
    Posts:
    57
    Location:
    Melbourne
    Hi all,

    In my late 20s sitting on approximately 260k which I've saved for a house deposit/LIC portfolio.

    The time has come to make a decision. Options are:

    - 50% deposit on a 500k property (we're in a regional area so house is more than suitable). Pay down mortgage ASAP then start an LIC portfolio.
    - 50% of funds (100k + fees) for a 20% house deposit and 50% into LIC portfolio.

    Factors to consider:
    - Living in a regional area so unlikely to see huge capital growth on property
    - Long term goal is to pay off house and build a passive income/retire
    - I earn 120k, wife was earning 80k but now on maternity leave with first child, unlikely to return full time for 2-3 years.
    - Slightly hesitant to jump into LICs prior to general election in May and possible changes to franking credits.

    My salary will more than cover the mortgage but there's a temptation to put down the maximum possible deposit to improve the 'sleep at night' factor, especially while we're on one income. I could hit the mortgage hard for 5 years and then start building LIC portfolio after that. However, I also understand the benefit of building a share portfolio early in life to allow for compounding.

    I'm keen to discuss the pros/cons of both strategies or even perspective from anyone who has been in a similar situation. Thanks in advance!

    Cheers.
     
  2. Terry_w

    Terry_w Broker, Lawyer, Tax advisor, Debt Recycle advisor Business Member

    Joined:
    18th Jun, 2015
    Posts:
    21,788
    Location:
    Australia wide
    Why not do both?
     
    Froxy and Redwing like this.
  3. JasonC

    JasonC Well-Known Member

    Joined:
    14th Mar, 2017
    Posts:
    90
    Location:
    Sydney
    Personally for me my sleep at night night factor would be higher paying a 20% deposit and having the extra 30% sitting in an offset against the loan, than paying a 50% loan and have no cash buffers. Then if there was sudden loss of income I'd have a long time before it would affect the ability to pay the home loan. Then again I can trust that we won't frivolously spend the cash sitting in the offset account.

    Have you thought about doing both (buying shares and paying down mortgage)? Have you read about debt recycling?

    Is this PPOR going to be your forever home? If you decide to upgrade in X years would you keep this place as an investment property, or would it definitely be sold?

    In your position I would consider:

    Doing 20% deposit on home loan (depending on serviceability), putting 30% in offset account against the loan.
    Start debt recycling by buying a combination of LIC's/ETF's using money drawn down from a separate split on your loan. As you make additional repayments on the PPOR split, lower the available balance on that split and increase it on the investment split. Buy more LIC's/ETF's.
    All the while paying IO on the investment split and P&I on the PPOR split (directing any extra repayments here).

    Regards,

    Jason
     
    sgillys and Ryan Thomas like this.
  4. itsmescottyc

    itsmescottyc Well-Known Member

    Joined:
    5th Jan, 2017
    Posts:
    57
    Location:
    Melbourne

    @JasonC I don't mind the idea, but my understanding is that debt recycling can make things more difficult from a cash flow perspective, as you also need to be able to cover the additional expenses of the investment loan each month.
     
  5. JasonC

    JasonC Well-Known Member

    Joined:
    14th Mar, 2017
    Posts:
    90
    Location:
    Sydney
    Depends what you are debt recycling into and what your home loan rates are. I have a suitable loan with IO rates in the range 4-4.5% and you can get ETF/LIC's paying similar or higher dividends - additionally with franking credits adding to that. So incl franking credits you can be getting approx 6% on the major AU ETF/LIC's.

    So it should be cash flow positive from the start however there may be a lag as dividends are paid at best quarterly, some six monthly or annually. For the franking credits you may need to wait until your tax return.

    Additionally the plan (hope?) long term is that the dividends increase on a year by year basis. So what was slightly positive to begin with is significantly positive in a few years time and helping to pay down your PPOR debt.

    Regards,

    Jason
     
    KayTea and Froxy like this.
  6. itsmescottyc

    itsmescottyc Well-Known Member

    Joined:
    5th Jan, 2017
    Posts:
    57
    Location:
    Melbourne
    @Terry_w apologies for my ignorance, but can you expand on that?

    Cheers
     
  7. Terry_w

    Terry_w Broker, Lawyer, Tax advisor, Debt Recycle advisor Business Member

    Joined:
    18th Jun, 2015
    Posts:
    21,788
    Location:
    Australia wide
    You could split and then pay down a main residence loan then reborrowing to buy shares you could claim the interest
     
  8. itsmescottyc

    itsmescottyc Well-Known Member

    Joined:
    5th Jan, 2017
    Posts:
    57
    Location:
    Melbourne
    @Terry_w what might the structure look like?

    130k deposit, then throw in the other 130k and then access this equity to buy LICs and debt recycle?
     
  9. Terry_w

    Terry_w Broker, Lawyer, Tax advisor, Debt Recycle advisor Business Member

    Joined:
    18th Jun, 2015
    Posts:
    21,788
    Location:
    Australia wide
    It could be something like 80% loan to start with and 9 X $20k splits with one large split for the rest.
     
  10. Fargo

    Fargo Well-Known Member

    Joined:
    23rd Jun, 2015
    Posts:
    728
    Location:
    Vic
    I am not sure how he is going to get franking credits when Bill is taking them away. or on such a high income probably wont get much anyway. Franking credits is pretty much irrelevant. What is relevevant is CG tax it may be better to buy shares before 28th march when I have heard the 50% CG discount will be removed, I suspect recent strength in the share market may be people pre-empting tax changes so if Scomo is elected their maybe a temporary down turn and better buying,
     
  11. Gestalt

    Gestalt Well-Known Member

    Joined:
    20th May, 2018
    Posts:
    58
    Location:
    Brisbane
    Labor proposes to abolish franking refunds, not credits.
     
  12. Andy909

    Andy909 Active Member

    Joined:
    5th Mar, 2017
    Posts:
    30
    Location:
    Sydney
    What is the concept of splits, sorry I am hearing this for the first time ?
    The OP has option to transfer $150k to spouse and purchase ETF/dividend stocks in her sole name so that her minimum tax threshold can be used minimize the tax.
    And if you want to be aggressive use the $260k in deposit. This reduces the home loan interest. Then borrow the equity to invest in ETF/dividend paying stocks, the interest is claimable as expense. Use spouse sole account to invest and leverage this $250k with margin lending upto $1 mil. If you can't sleep with $1mil borrowing start with small borrowing. I think this strategy will have the highest return and lowest tax.
     
  13. Terry_w

    Terry_w Broker, Lawyer, Tax advisor, Debt Recycle advisor Business Member

    Joined:
    18th Jun, 2015
    Posts:
    21,788
    Location:
    Australia wide
    split so you can debt recycle - bits at a time if need be, or separate parcels of shares.
    Can still invest in spouse's name
    can still claim interest
    but get owner occupied rates, overcome cash out restrictions
    Spouse could separately margin loan as well

    Get some tax advice with your loan advice and go further with less tax and less interest.
     
    Andy909 likes this.
  14. Zenith Chaos

    Zenith Chaos Well-Known Member

    Joined:
    10th Jul, 2015
    Posts:
    1,128
    Location:
    Sydney
    I paid off my PPOR before buying equities. My theory was it was a guaranteed after tax return - I am probably on the side of risk averse. However, based on what I know today I would debt recycle conservatively into ETFs - if you want a more substantial passive income stream add LICs. Equities is about "time in the market" rather than "timing the market" so waiting until your PPOR is paid off means lost time.
     
    Parkzilla, sharon, mdk and 3 others like this.
  15. The Falcon

    The Falcon Well-Known Member

    Joined:
    18th Jun, 2015
    Posts:
    2,480
    Location:
    Sydney
    Honestly would not bother with debt recycling personally. You introduce another area of potential to stress and fiddle.....the downside risk is never mentioned by those promoting it, nor the behavioral considerations...just spreadsheet outcomes. Given what we know about loss aversion I would take the known win of debt reduction and then invest. Crunch the numbers on salary sacrifice as well as that may make sense until ppor debt is gone.
     
    MWI, Parkzilla, sharon and 6 others like this.
  16. Nodrog

    Nodrog Well-Known Member

    Joined:
    28th Jun, 2015
    Posts:
    7,646
    Location:
    GONE
    I’ve decided to avoid debt in retirement. But even prior to both of us being retired debt was only used conservatively when equities offered exceptional value then repaid ASAP. I’m not in favour of using debt for equities otherwise.

    In summary new cash only for regular investing (DCA) and conservative use of debt (or none) during major gloomy times.
     
    Parkzilla, sharon, Snowball and 2 others like this.
  17. Barny

    Barny Well-Known Member

    Joined:
    16th Oct, 2015
    Posts:
    2,502
    Location:
    Australia
    Bill wants it back dated to 1st July 2017. So buying shares now will still fall under the 25% capital gains discount.
     
  18. Snowball

    Snowball Well-Known Member

    Joined:
    28th Dec, 2016
    Posts:
    658
    Location:
    Perth
    I wrote a post about this (debt recycling) and went to some effort in noting the risks and things people often don’t consider, because it’s very true that people seem to get lost in spreadsheet land!

    If someone wants to link it that might help those weighing it up.
     
    sharon likes this.
  19. Nodrog

    Nodrog Well-Known Member

    Joined:
    28th Jun, 2015
    Posts:
    7,646
    Location:
    GONE
    https://www.strongmoneyaustralia.com/debt-recycling-ultimate-guide/
     
    sharon and Snowball like this.
  20. Terry_w

    Terry_w Broker, Lawyer, Tax advisor, Debt Recycle advisor Business Member

    Joined:
    18th Jun, 2015
    Posts:
    21,788
    Location:
    Australia wide
    I skimmed that article on my mobile but I think your approach snowball is different to mine. Debt recycling is converting existing non deductible debt into deductible debt, so it doesn't involve borrowing extra money but paying down a loan and redrawing so the overall debt level is the same.

    If you don't do this and just invest you are shooting yourself in the foot by losing tax deductions.

    So a person that still has a home loan really has only one choice and that is to debt recycle.