Paying down PPOR mortgage or invest

Hi guys,

I am currently trying to understand the benefits between paying down a PPOR mortgage where the interest on loan is not deductible vs. using the equity in the home to invest in index tracking EFTs (interest on that amount would now be deductible) earning higher returns over the long term.

My understanding is this:
1. The interest on mortgage is say conservatively 3%
2. The interest on the invested funds would become deductible (as long as you redraw or take out a new loan like IO or line of credit for investment purposes), therefore on $100k borrowed to invest, the interest is $3k but this $3k of interest is now deductible as it is used for income producing assets therefore you are only paying $3k x 53% (if you are on the 47% marginal tax rate)
3. Index funds return an average annual return of 7-10% pa.
4. Paying off the mortgage is tax free but this is offset by the fact that the interest payable on the invested funds is converted from a non deductible debt to deductible, therefore the real return is comparable i.e. 3% mortgage versus 7-10% stock market returns
5. Index funds also pay a dividend which is partially franked. Currently at around 2% which approximates the lower end of the interest rates at the moment.

Is it a no brainer to invest for the long term using equity in your own home to earn a return of 7-10% pa versus a guaranteed 3% paying down the mortgage?
I understand there is greater risk and volatility investing in the stock market index however, we are talking long term 20-30 years outlook.

 

Can you really get those returns?

Your question seems to imply it is one or the other. Why not do both? Pay the loan down, reborrow and invest.

 

Terry those returns are from the entire history of the stock market, average annual returns since the beginning.

My question relates to exactly what you outline: i.e. pay down the loan, redraw or take out an investment loan (so that it is deductible) and then invest. But was just wondering if my train of through comparing the scenarios is accurate or not.

 

If u pay down and invest by using redraw the interest will generally be deductible.
If you use cash to invest interest on the home loan won't decrease so more tax would be payable.

 

Do banks allow to use equity in your home to invest in shares?

 

Yes

 

I'd like to ask a question here.

If I have 50k shares and am buying a PPOR soon, would it be worth it to sell the shares, pay down 50k on the loan, reborrow the 50k and invest back into shares? Is this worth it for the tax deductions?

 

Questions to ask yourself:
How much tax would you save on $50k?
What is the CGT on the sale?
What if the shares rocket in value after you have sold?

 

Debt recycling strategy - agreed with comments above, use redraw, reborrow and reinvest

 

Long term earning 7-10% day in day out. That's pretty good if realised. Maybe I am a small thinker...

 

Also worth mentioning if there is a loss and you intend to buy back this is considered a wash sale and not allowed within 30 days of sale

 

Conservatively, if your loan is at 2.5%, and you are on 47% MTR then you effectively pay 1.325% in interest. A common ETF VAS which tracks the aussie index is currently paying slightly over 2% in dividends a year. This is also partially franked so most of it is tax paid. On this alone you would be ahead. Any additional capital gains is just cream on the crop is how I see it.

 

Wouldn't using redraw make the loan mixed use?
When using a Debt recycling strategy it is better to create a separate loan split for the money to be invested, getting the structure correct is important.

 

I think he means to use the redraw funds to take out a new loan for investment purposes

 

You need to create a separate loan split, using the equity, do not use redraw.

 

Are you sure redraw is recommended? I’d think redraw would cause mixed funds and mess it up and make it muddy.

 

Thanks Rolf, is this effectively the only facility that would allow you to increase your investment loan as you build up equity?
My understanding is most other lenders requires you to apply for a new loan ever time you want to increase the loan say for example you've saved up 50k and want to invest it every 6 months