Paying down PPOR mortgage vs Investing

Hi guys,
Been reading about paying down PPOR debt (non deductible debt) VS investing (debt recycling) and turning that non-deductible debt into deductible debt. I realise that debt recycling is not for everyone and that there are a lot of variables to consider for it to work but i'm mostly interested in the numbers.

Basically the idea is that if you choose to invest over paying down PPOR debt, the after-tax return you get on your investments should be greater than the interest rate on your mortgage.

Without overcomplicating things and assuming a 5% Interest rate on PPOR mortgage, does relying on the below simple numbers make sense ?

Investment returns required by Income bracket
Personal Income Bracket $18,201 – $37,000 $37,001 – $87,000 $87,001 – $180,000 $180,001 and >
Marginal Tax Rate 19% 32.5% 37% 45%
Pre-tax return required 6.2% 7.4% 7.9% 9.1%

PS: i'll dig up the formula to calculate the Investment returns required later on

 

This doesn't make sense to me.

To be ahead all you need for your debt recycling investment is to earn more than the interest you are paying on the bank loan. So if you are paying 4% to the bank the after tax return on both income and capital gains has to be more than 4% for you to be ahead.

 

Terry is correct.

I get what you are trying to figure out.
If you had cash money, and invested it, then yes you would need to earn a lot more than if you left the money in the bank.

HOWEVER.
What you are doing with debt-recycling is borrowing at say 5% in your example.
This amount is deducted from your profits as a business cost. THEN you calculate your tax rate on the profits.

So even 1 cent after you've deducted 5% interest is profit. Then you apply the tax rate.

This is easily done with IP's as you leverage to borrow debt. So in simple terms, a 20% rise in property price, on 80% LVR is 100% cash-on-cash return. The less you LVR, the more you diminish your returns.

 

fair straight forward if you use risk free vs non risk free return
paying down mortgage is a risk free return of 4% after tax so it any between 5-7% for some people defend on their tax bracket.

In order to compensate for risk free return you have to factor your market risk premium
are you happy to earn an extra 3% or 5% or 10% and face the risk of losing money?
that is up to each individual risk tolerance.

Say you demand a 5% risk premium then to justified investing over paying down mortgage your return rate has to be around 10-12%

because losing money in properties or shares is real so you have to taken that into account and hence risk free rate is always lower because you don't face capital loss

Tax is a side issue, capital preservation and risk assessment trump all that

 

And don't forget, tax is just the icing on the cake but not the cake itself..

First thing to consider when investing in property is asset growth/capital gains..

 

Thanks very much for the replies guys, much clearer now.
@NHG , you are spot on as in i was conflating debt recycling with simply weighing in wether investing some cash or paying down PPOR is more beneficial.

 

I've decided to ask an awkward question regarding the paying of 3 loans, 2 properties.


(Pic is attached)

Loan 1: PPOR - $425.6k approx (excluding offset of about $100k)
Loan 2: (non deductable: purchase of PPOR) - $152k approx owing.
Loan 3: Part of loan 2, split - ATO approved investment (old PPOR) = $44.2k owing.

My actual question: Should I use 100% current offset $ to pay down Loan 2, or should I Pay it down to say $53k? (To make it less then 100k owing)

I / We plan to get split loan 2 (non ato) paid off within 3 years or so. So after putting current offset balance into it, we will still put all wages into PPOR offset account; but upgrading the payments into loan 2 by an extra $1900 ish (already pay $105 extra each month!).

Income going in will include:

- Rent
- Wage 1
- Wage 2
- Other tax free income which is legally received as required.

If we ride out the loan contracts: 28 years remain for all 3 loans (same bank, rates = less then 4%).

Tax agent / finance advisor is agreeing with me to pay off loan 2 (old ppor) faster. Am I insane cutting off $100k from our current savings offset?

 

whats the advantage in paying off the loan 2?

(and what the heck is an ato approved investment!?)

 

Investment property has 2 loans on it.

Tax deductable (ie: ato approved) & non tax deductable (used to purchase current PPOR).

Advantage: Less interest charged, once gone (or even lower debt) we have more flexibility on another property. Either investment (keep current PPOR), or New PPOR (current house changes to investment).

Once loan 2 is fully paid, all saving are on the largest loan (loan 1).

Total non deductable debt is: $577k approx, spread over 2 loans.

 

If you have an offset account attached to either 1 or 2 and both loans are the same rate you won't be saving any interest if you pay the loan off.

If you are considering moving main residences then it would be better not to pay the loan off.

Paying the loan down may help serviceability slightly though.

If it was me I wouldn't be paying the loan down faster than the min repayments.

 

Loan 2 isn't attached to our current ppor.

It was once our old house, which we used to get our new home. With the original debt owing of just $50k. (Which was allowed as investment debt).

Loan 2 & 3 was originally just loan 2, before they were split. Making it easier during tax time for the investment portion of the loan.

We will always only pay the minimum for loan 1 (our ppor), incase it ever changes to investment status.

But load 2 is not worth waiting nearly 30 years to pay off.

I doubt I can explain it in simple terms.

 

Security for a loan doesn't matter. Loan 2 is still not deductible so whether you pay down 1 or 2 won't change interest savings and if you pay down a loan or keep the money in the offset won't change interest incurred.

I would keep saving in the offset account and then once you want to invest or buy another house then you can decide whether to directly use the cash or pay down the loans.

 

Hi @Snowball

I noticed your last blog.
Mortgage, Investing or Super - Where Should You Put Your Money? - Strong Money Australia

It has some major mathematical errors;
· On the treatment of the 50K capital.
· How compounding effects early mortgage repayments.
· Capital Gains tax impact on the investing option.

If the numbers have had any influence on your paydown/invest opinion you probably should get them correct. Or at least get it correct for the sake of the people beleiving you when you tell them what they want to hear and can't see the error in the numbers for themselves.

Do you want me to explain – I am more than happy to do other things if you are not interested.

 

Thanks mate someone else has pointed out the error to me and I’ll go over it again when I get some time, busy with family at the moment.

 

I’m pleased you are going to look at it.

Correct numbers should look like this.


Happy to run you through the calculations if required.

Once you have built a model like this you could do some sensitivity testing around mortgage and investment rates changing. Much more informative (and scary) than just working with a single scenario given that to get the 3% after tax(47.5% marginal) income and 3% growth rates requires a pre-tax 8.57% return – that’s a pretty heroic equity risk premium above the current risk-free rate. The only way you earn that sort of ERP is by enduring heaps of volatility.

 

Worth noting too that for those intent on smashing their mortgage down in a much shorter time - say 10 years, the difference will of course be even less - with possibly more volatility risk.