It must be a joint decision that suits your ‘money personalities’

Wow, Jason, that is a really impressive – a great effort by you and your wife. Your question is also a good one. ‘When is the right time’ is a question that we all face when it comes to life and, of course, our money.

The critical factor in your wealth creation is not when you buy an investment property. You are already fully engaged with the most powerful wealth-creation rules.

First, you are all over my rule number one: spend less than you earn. Absolutely zip happens with wealth creation unless we can engage rule one.

Then, by saving, creating a deposit and buying a home, you hit other key wealthcreation tools – investing in growth assets, such as a home, investing in tax-protected assets, such as a family home, benefiting from compound returns and also paying off non-tax-deductible debt.

Before we can use proven money rules to help with a timing decision, we have to also factor in ‘us’. This is always fun.

My wife, Vicki, was about to go to play bridge, so I read your question to her. She is really good with money, but has a different ‘money personality’ from mine. I was pretty certain what she would say. Sure enough: “pay off the mortgage, then invest”.

Her argument is totally valid. Technically, it is hard to beat paying off debt that is not tax deductible. I imagine your home loan rate is about 6%. Paying it down means you are earning 6% tax free and risk free on your money.

Vicki also said ‘life happens’, her point being: what if there was an economic downturn and you lost your job, suffered an illness or something else bad happened? We’ve been married for 41 years and you already know what we did decades ago – paid off our mortgage, then started investing!

When we were about your age, I had a chance to leave my job to start an investment business with four others. Vicki came along to the meetings to discuss this and strongly encouraged me to quit and go to the start-up.

This sounds like a more aggressive attitude to money, but she was in a secure job teaching, so she argued that we should delay starting our family for a couple of years, until the business could pay me a salary. If it could not do that after a couple of years, I should go back to a ‘real’ salaried job.

Vicki is not risk adverse; she wants to control risk. Having one secure job and a focus on paying off our mortgage before any other investing was important to her. She knew I could get another job if the business did not work out. So, giving it a go, with great partners and an excellent business plan, while relying on her job for income, made a lot of money sense.

How a couple works together on their money is an important part of my answer to your question. You have to factor in your situation, job security, salary growth prospects and attitudes to risk before you can move forward. That I have to leave to you.

Opportunity cost

But now we move to my opinion, which is biased because of my money personality.

The opportunity cost of you buying an investment property is your mortgage rate, say 6%, on redirecting your money away from your mortgage. So, will you earn more than 6%, after tax, on an investment property?

Paying down your mortgage is risk free. Long-term returns on property and shares are in the range of 3% to 5% above inflation. But with an investment property, this sort of return is magnified, for better or worse, by gearing.

An example may help here, but I have to keep it simple. So, we are not including mortgage costs, stamp duty, potential land tax, agent fees, rates, insurance, maintenance and a lot more.

Let’s say you buy a $500,000 property with a $50,000 deposit. We’ll set rent at 4% of the value, so $20,000. An investment loan is, say, 6.5%. On $450,000 that is $29,250. Deduct rent of $20,000 and you need to find $9250 a year, which is tax deductible. (This is being debated as part of tax reform, but we’ll go with current legislation.)

The growth is the critical return element. If it grew at a conservative 5%pa, the average increase in value is only $20,000pa. But this is the magic trick of gearing. You have only put in $50,000. A $20,000 return on $50,000 is 40%pa.

Yes, I know, I have not allowed for the $9250 a year you have to put into the property, nor do I know your tax rate and the deduction that gives you, but we are dealing in money principles here. You can work out the details before you invest.

With my money personality, if I was in your shoes, with so much equity and solid savings, I would not wait the eight years to pay off the mortgage. In my case, this would have been entirely academic as Vicki would have said: “We’re taking a risk with your business succeeding. Any surplus income goes into the mortgage and we revisit investment when it is paid off and we have the title deeds to our home.” There is only one good answer to this, in particular as she is right, and that is ‘yes’.

I can only set out the money principles. From here, you and your wife need to have a good chat about your financial situation and make sure you come to a conclusion that fits both your situation and your money personalities.