In this crazy debt-fuelled world that we live in, paying off a home loan faster is often seen as a sign of financial success.
However, the mortgage is usually the very last of your household debts that you should be paying extra off.
That’s because it’s a percentages game, and one that every borrower should understand.
Sure, if a mortgage is your only debt, kill it off quickly. But if you’re like many Aussies and also have credit cards, store cards, car loans, personal loans, and possibly a short-term cash loan from a scary brute named Crusher, those other debts should all be wiped out first (particularly Crusher’s).
Put simply, a home loan is likely to be charging the lowest of all of your interest rates. That means all the other debts are costing you more, even though the biggest repayments go to the mortgage because of the loan’s size.
While a $10,000 credit card debt at 18 per cent interest will cost $1800 a year and a $200,000 mortgage at 5 per cent costs a much larger $10,000, paying off the card first means you are effectively earning a “return” on your money of 18 per cent on the card, versus just 5 per cent on the home loan.
In other words, you would need an investment earning 18 per cent a year to make it a financially better move than paying off the credit card debt, and one earning 5 per cent to beat the mortgage repayment. Bank deposits are paying below 4 per cent interest, so avoid them.
There also is a psychological benefit in wiping out the smaller debts first because it feels like you’re getting on top of your finances.
Once the smaller, expensive debts are paid off, you’ll have more to pump into the mortgage.
There are couple of situations where rules can be broken. If you have student debt with an effective interest rate in line with inflation – currently 2.4 per cent – it can make financial sense to rank mortgage repayments above that debt.
Also, if you are a real estate investor who has borrowed for an investment property, you should pay off your own mortgage first and have an interest-only investment loan, which is tax-deductible.
Controlling your debts starts with understanding the interest rates you are paying.
Story: Anthony Keane Source: www.news.com.au
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Hicks Real Estate Team
Hicks Real Estate is a Brisbane based, full-service real estate agency supporting buyers and sell as well as renters and property investors. With almost 20 years experience in the local market, we are the real estate experts you can rely upon.
