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Should I pay off my mortgage or buy an investment property?

Should you get an investment property or pay off your mortgage? Image: Getty

The Reserve Bank of Australia has taken interest rates to record lows, meaning many Australians are now considering whether to buy an investment property. 

A loosening of tough credit rules for investment loans has also made property investment an easier prospect than it was years ago. 

However, that doesn’t mean it’s always a good idea.

We asked Canstar to crunch the numbers on whether someone with a mortgage would be better off paying off their mortgage quickly or investing in a second property. 

The assumptions: 

To carry out this experiment, the researchers looked at a couple who purchased a home five years ago for $560,000 with a 20 per cent deposit. That means they took out a $450,000 home loan. 

Assuming the five-year annual property price growth was a conservative 4 per cent, the home is now worth $684,000, so the owners have around $277,000 in equity after paying down the mortgage for five years. 

“It’s worth noting CoreLogic data puts the annual property price growth at 6.8 per cent nationally for the last 25 years, though we’ve taken a more conservative approach with this hypothetical analysis,” Canstar's finance expert Steve Mickenbecker said.

Using that equity and the property price increase, the borrower can now consider buying an investment property worth around $678,000. 

Here’s what would happen either way: 

The above is an example of the benefits and opportunity costs of purchasing an investment property or contributing extra to an owner occupier loan. Outcomes will vary depending on property purchase prices, loan amount/s, property value growth, investment property expenses and income and interest rates. Extra monthly contribution in scenario A is based on the average monthly costs of the investment property over the life of the loan (30 years) considering rental income, investment property expenses and applicable tax deductions. In reality the income or costs of an investment property can vary year to year and change over the life of the loan. Upfront costs such as stamp duty and government fees are assumed to form part of the borrowed amount. Interest rates used are the average variable rate for owner occupier loans at 3.87% ($450,000 loan at 80% LVR), and investor at 4.25% ($450,000 loan at 80% LVR). Equity from owner occupier loan at year 5 is based on 4% annual growth in property value from an initial value of around $562,500. Landlord expenses applied in the calculation of investment property costs in year one include landlord insurance ($1,365 per annum), land rates ($1,907 per annum for a $500,000 land value in the Penrith City Council region), stormwater charge ($25 per annum as per the Penrith City Council region), maintenance as 1% of property value, property management costs as 10% of rent, and interest charges. Investment property income is based on median weekly rent in Sydney of $540 (Domain, March 2019) with assumed annual vacancy rate of 3%. Source: www.canstar.com.au - 30/10/2019

I need that in writing

Let’s break that table down. 

If these hypothetical borrowers were to continue making their current monthly repayments of $2,114, it would take them the scheduled 30 years to pay off the loan. 

If they were to instead forego the investment property and make additional monthly repayments of $2,169, they’d pay off that initial loan in 14 years and 6 months. 

That’s assuming that this couple would be able to top up their initial loan with the funds that would have otherwise been used to service an investment loan - the monthly loan repayment of $3,470 minus the amount they’d be receiving in rental income ($2,270) and tax return ($73), plus the investment expenses they’re not incurring ($1,042). 

If they were to use their equity at the five year mark to buy a $678,000 investment property, in order for them to profit, both properties would need to appreciate by at least 1.4 per cent a year. 

Any growth lower than that, and paying off their initial loan would have been the more profitable option. 

If you’re receiving 4 per cent growth with an investment property, you’re looking at equity at 14 years and 6 months of $1.5 million - significantly higher than the $1.2 million if you’d chosen to supercharge your mortgage payments instead. 

But if you received growth of less than 1.4 per cent, suddenly that decision to invest in a second property will see you with $497,605 rather than the $684,000 if you’d chosen to supercharge your initial mortgage. 

“So, while we’ve laid out a number of these scenarios there is no one overall winner here as it will be dependant on how the housing market performs,” Canstar finance expert Mickenbecker said.

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