Should I pay off home loan or invest?

Hi,

I currently have $50,000 in a internet saving account that is earning a whopping 3.75%.

I also have three home loans on two investment properties. Balances are approx:
a. Property 1 - $40K
b. Property 2 - $55K & $100K
All loans are currently at 6.01% P&I.

I have purchased a block of land off the developer that is due to be titled in Mar 2011. I will then owe approx $180K on it.

My current tax bracket is 38%.

I have two small kids (3 and 2 years old) and a third arriving in late march. My wife is not working, nor will she return to work due to poor health.

My question is; What should I do with my $50,000? I see my options as:
a. Do nothing, ie leave it how it is
b. Pay off Property A loan, noting that an early repayment fee of approx $500 will apply.
c. Pay chunks of Property 2 loans, noting that the early repayment fee will be approx $650 or $715.
d. Pay $10K of each of the three loans which can be done for zero fees.
e. Search the internet and ask some people who are smarter than me for better options or advice.

I chose option e.

Can you please advise what you think would work best for me or if you require additional information (not sure what else I can tell you)?

Cheers,

Ted

 

Ted,
There are some smart people who use this site, so well done for asking the questions.
I presume the IP's are now positively geared given the low loan amounts (or very cheap housing) so it would assist to know a few more things:
1. Ownership structure of IP's - sole, joint or trust?
2. Value of properties
3. Are you currently renting or have you paid off your own home?
4. Do you have any other non deductible debt?

Wealth is assets minus liabilities so people can do one of three things, increase assets, reduce debt or both. As a general guide, in the income earning phase of life, most investors choose to increase their income producing asset base rather than reduce debt. It is using other peoples money wisely to build your asset base, so most investors will not pay any principal down on income producing assets and just use interest only loans to build their equity base to purchase again.

I would suggest you give thought to converting these loans to IO and if you do not have any private debt, set up an offset account with the largest investment loan and park your surplus funds there. It will reduce your interest income (and tax payable on it) and reduce your overall expenses.
Alternatively set up a bank account in your wife's name (and get a better interest rate) so the interest earned is in her name, not yours.

There are numerous ways to proceed so I suggest you find an experienced finance strategist who understands wealth creation and have a long discussion of what you want to achieve and your time frame.

There will be others who are dead keen on the share market, some will suggest super and others property and all can work but it will depend on your goals, time frame and comfort levels.
Good luck
Greg

 

Ted

I'll need more info,

Are your properties in Darwin?
Start by answering Greg's questions pls and let me know if you are paying rent.

Also, what was your thinking when you bought the land?

 

Greg, Bill,

Thanks for the quick response. To answer your questions:
1. IP 1 - Sole property (late 80's 3 bed house) in my name only. Value ~$250K. It is in Caboolture, QLD.
2. IP2 - Property (3 year old 1 bed flat) is in joint names however for tax purposes, I own it as all rent gets paid to me, and all expenses come from my pay. Value ~$300K. It is in Sydney.
3. I am renting at the moment but my rent is cheap as it is subsidised by my work.
4. My only other non-deductible debt is normal credit card stuff but this is nearly always paid off in the interest free period.

Re the IO option, I haven't considered that this time as I got a little burnt doing that when I first purchased Property A. I looked in IO for 5 years at 9.75%, just before interest rates started to drop (1992-ish). It isn't a bad option though thinking of it now as it will free up some cash. The largest loan already has the offset account so that is possible too.

Other info I neglected to mention before is that the $50K is currently in my wife's name. As she is not working, the interest earned won't be taxed as highly as if I had earned it. I am however sure that I should be able to find a better interest rate.

As for shares, I already have a reasonable portfolio so that option doesn't scare me and I do have family in Singapore who lecture on investing in their market so we have looked at that too. As an aside, I also looked at borrowing for my investment properties from my family as Singaporean interest rates were at around 2% at the time. The ATO gave me clearance to do this and to claim the interest as a deduction provided I had an arms-length agreement with the family. The only reason I didn't go ahead with this was for the fx risk.

Lastly Bill, to answer your question with what I was thinking buying the block of land. Good question but simply put, I move every 2-3 years with work and bounce from rental to rental. I wanted to find a home for my family where I didn't have to ask someone for permission to put a hook in the wall. Also, as Darwin rental market is rising in a ridiculous fashion, I wanted to get in on it. I didn't want to pay $30K stamp duty on a home so I went for a block of land that I could build on. The 800+m block for $200K was also a better option than established blocks which are selling for $250K for ~700m. As it turns out, I will be moving interstate possibly before the house is completed; hence I will be unlikely to ever live in it so it will become another IP. This isn't a problem as rents are skyrocketing too. In 2008, my rent was $480 per week. In 2009 it was $550 and will remain as such until Jun 10. Yesterday, my landlord told me he rented and identical property in the same street for $650 per week. I want to tap into this market and I think a new house in a new suburb (not one house exists yet) will be worth a shot.

Anyone, thanks for your assistance and you patience with my possibly too long answers.

Cheers,

Ted

 

Why not put the $50k cash into 100% offset accounts? Then the effective rate will be 6.01% against your IP loans, rather than 3.75%, by simply reducing your interest payable. An offset account is just like a normal savings account in all other aspects, it just works for you better than a standalone account (even better than a term deposit at 6% since you have access to your funds anytime).

IO loans don't have to be locked in, you can go for an IO variable loan at the same rate, freeing up the principal payments... but since you don't have non-deductible debt, this has less relevance at the moment. You're not being silly paying down the debt, but this can be done within an IO structure - you just make payments when you wish to.

Once your new block starts costing you, interest will (probably) be non-deductible until it's available for rent, so consider how you minimise costs during the building phase... check with an accountant as to how to set this up...

 

Ted

I wouldn't pay down any more debt.
In fact I'd access the equity in 1 of the properties to go more into debt
to take advantage of future capital gains and to reduce my tax bill.

Considering that your wife is not working, keep the $50K as a cash buffer in an offset account, and perhaps link it to property 3?

Is that property also in both names?
Are you working for the defence?
Is your wife going to follow you when you move?
Have you got landlords insurance for both of your properties?