FAMILIES
Paying off your home loan quickly makes a lot of sense. It saves you a fortune in non-deductible interest and once the home loan payments are out of the way, you have extra resources available to start an investment program.
But how quickly should you pay it off and at what stage should you favour investment instead? To answer the question, you need to understand the way compound interest works. The earnings on an investment are small at first, but grow faster and faster as time passes. It works the same with a loan, the interest bill grows as the term lengthens but you don't save much interest by speeding up your repayments once the term is less than ten years.
For example, repayments on a $100,000 loan over ten years at 6.5% are $1135 a month. To reduce the term to five years, you need to raise the payments by $822 a month to a massive $1957 a month, yet reducing the term by five years only reduces the interest from $36,000 to $17,000.
The $822 a month is much better off invested elsewhere. A good share trust is the perfect place to put it as it will provide diversification as well as tax benefits. If you had started 10 years ago and invested $822 a month into a trust that matched the All Industrials Accumulation index your portfolio at 31 December 2001 would be worth $196 000.
Other options include taking out a regular gearing plan or some straight negative gearing. Naturally you should talk to a financial adviser and choose the strategy that best suits your circumstances. However, the message is clear - lower home interest rates open up a range of investment opportunities to those who have a secure income.
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