NOEL WHITTAKER'S $12 A THOUSAND A MONTH RULE
Because of the way numbers work, you save little interest by reducing the term of your housing loan to less than ten years. The money used to pay back the debt any quicker is better used for investment.
Example
The Smith's and the Jones's are neighbours and they are aged 40. They owe $100,000 on their home which they are repaying at $1,200 a month ($12 a thousand a month). The Smiths' are a nervous couple and decide to pay their home back in five years but to do this they have to raise their payments by $822 a month. They do reduce the loan term to five years but save only $19,000 in interest.
The Jones' leave their home repayments untouched but take out a $200,000 interest only loan to buy blue chip share trusts - his repayments are a tax deductible $1,100 a month. At age 50 their home is paid off and they invest the $1,200 no longer needed into superannuation - it may be worth $470,000 at age 65 when they withdraw $200,000 tax free to pay off the investment loan. By then the managed funds may be worth $2.4 million.
They arrive at age 65 with their home paid off, the investment loan paid off, an EXTRA $270,000 in super and $2.4 million in managed funds.
When the Smiths' get to age 45, their home will be paid off but if they want to have $2.4 million at age 65, they will have to invest $350,000 - almost twice as much as the Jones'. Because they are nervous, they wouldn't borrow to that extent but if they did, the payments would be a tax deductible $1,900 a month. If they did take the big step, they would arrive at age 65 with $2.4 million in managed funds but with a debt of $350,000. They would then have to sell part of their portfolio and pay CGT to liquidate the debt. They also wouldn't have an extra $270,000 in superannuation.
Example
Mary has $100,000 line of credit loan for the purpose of buying an investment property. Her grandmother leaves her $25,000 in the will and she "parks" this into the loan account while she decides what to do with it. Six months later, she withdrew it to do some repairs to her private residence. This redraw is treated as a new loan and the interest on it will not be tax deductible as the purpose of it was for private use.
Example
You have a loan of $150,000 for investment and you wish to pay it off in ten years. You can take out a ten year P& I loan and repayments will be $1742 a month. The total repayments will be $209,000 of which $150,000 is principal and just $59,000 is interest.
Alternatively, you could leave the loan as interest only and the payments will be a tax deductible $875 a month. You could then put $867 a month into a share based insurance bond which should be worth $150,000 in ten years at which time it can be withdrawn tax free to pay off the loan if you wish. You still pay back $209,000 but this time, $105,000 is tax deductible interest and $104,000 is from after tax dollars.
BASIC PRINCIPLE
Every dollar you invest in paying off a loan earns you the equivalent of paying off the interest rate after tax. For example, money paid off your non-deductible housing loan earns you around 6.5% after tax. Money paid off your deductible investment loans earns an effective rate of about 3.5%
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