Don’t increase loan repayments
QI have funds invested with a major peer-to-peer lender on a five-year basis, earning around 7% annually, with interest paid monthly. I’m about to get a mortgage for a new home build at 2.49% variable. Would I be better off sending the monthly interest across to the mortgage to pop up repayments or close the peer-to-peer loan and bulk up the offset?
Answering readers’ questions is always fun, but this month we have had some beauties that impact nearly all of us ... wills, boats, divorces, pensions and an army veteran. And your question, Kerry, rounds us out very nicely.
Now I get to talk about risk and return. It is screamingly obvious that 7% a year on a peer-to-peer loan is a cracking rate compared with the 2.49% you will pay on your mortgage. All else being equal, you’d take any excess income and take out another similar loan, as paying money into your mortgage only earns you the interest rate on your mortgage, 2.49%.
With a five-year peer-to-peer 7% loan, pretty obviously you are locked in for a while. A return of 7% is not outrageous, and the history of sensibly priced peer-to-peer loans has been pretty good. Obviously it is riskier than adding any savings to your loan.
But while interesting, that is not your question. Here at least I can be crystal clear. Any additional savings should not be added to your monthly mortgage repayment. You may not be able to access that again. Put it into an offset account. That way you can access the money and while you are saving interest you are not reducing your mortgage.
If I had a dollar for every time someone kept their first property as an investment and then bought another home, I would have a small fortune. The problem, of course, is that you want the maximum debt on your investment property and the minimum on your home. So, popping savings into an offset account means the money is available to you and your mortgage is higher. If you buy a new home in time to come, you use the money in the offset account. This means you have a smaller mortgage on your home and a larger, deductible mortgage on your investment property.