Opes Property Academy: Become Friends With Debt
Should you pay off your mortgage or reinvest? You’ll build wealth faster if you use the bank’s money to turbocharge your investment strategy, says Andrew Nicol.
8 October 2021
Become investment-friends with debt. Debt is a feature of property investment – not something to be scared of.
The benefit of investing with other people’s money is that you can buy much more valuable assets than you could on your own.
This multiplies your returns as your asset increases in value.
Here’s how it works
Say you have NZ$100,000 as a deposit which you can use to purchase a NZ$500,000 property.
If the property then increases in value by 20 per cent, it will be worth NZ$600,000.
This is not a 20 per cent return, but a 100 per cent return on your deposit.
Instead of NZ$100,000 invested within the property, you now have equity of NZ$200,000.
Many people in New Zealand think that property is an attractive asset class because there’s a housing shortage.
But the real reason property is an attractive class is that it’s easy to borrow against.
Supercharge your returns
Let’s take Clinton from Auckland – an investor I work with – who bought an apartment in Christchurch for NZ$385,000 18 months ago. He used a NZ$77,000 deposit to buy it.
In May 2021, he was interested in buying another investment property, so we ordered a valuation. It came back at NZ$530,000.
Once you take off his mortgage, he’s left with NZ$222,000 worth of equity. That means his equity increased 188 per cent over that 18 months.
Over the same time frame, property prices in Christchurch increased by about 27 per cent.
The key driver of Clinton’s returns wasn’t the increase in property prices, but the leverage. Using debt means that Clinton and other property investors like him can get much better returns than they would otherwise.
Why pay more tax?
Many people are unaware that paying down debt can lead to their paying more tax than they need to.
I see many investors who are determined to pay off their investment property mortgages. But often, that’s not the right financial decision. For instance, if you have a personal mortgage, it is almost always better to pay that mortgage down before paying down the investment loans.
That has two benefits.
First, it de-risks your living situation. If you can pay off your personal mortgage, then you can unencumber your property, so the bank has no claim to your home. That’s the case even if the worst happened and you defaulted on your investment mortgages.
Also, if some of your properties can claim interest deductibility, then you’ll pay less tax if you focus on paying down personal mortgages before investments.
Paying down personal debt is always a good idea. Paying down investment debt is not always the best financial decision.
It keeps you from investing
Most properties need to be ‘topped up’ each week when the mortgage is set to principal and interest.
The rent will generally cover the rates, insurance, maintenance, and mortgage interest, but the investor may have to pay the principal portion themselves.
If this costs NZ$150 a week, you might be tempted to put off investing in property until you’ve paid off your personal mortgage.
After all, you might not have the spare cash right now to pay your home loan and the investment top-up.
However, it’s still worth buying the property sooner rather than later, even if the debt’s not reducing. That’s because then you can benefit from any natural increase in value the investment might get while you’re paying down other debt.
On the other hand, if you wait to invest until you’ve entirely paid off your personal mortgage, that property may now be more expensive and cost you more.
What if I inherit some cash?
If you inherit some cash, should you put it against the mortgage?
Let’s say you’ve paid off your personal mortgage, and you are paid a bonus or receive an inheritance of NZ$30,000. You might think it’d be good to pay off some of your investment mortgages.
That might be true. But remember, that once you put that cash towards the mortgage, it’s spent. You’ll then need to apply to the bank to borrow it back.
That’s why many investors will use a ‘revolving credit’ or offset mortgage to reduce their interest repayments while also having access to the cash.
This works a bit like a giant overdraft.
In this case, you could take a NZ$30,000 portion of your home loan and set it up as a revolving credit.
You can then use your inheritance to pay off that revolving credit. This reduces the amount
of interest you’ll pay over the life of the loan.
But then, if you ever need to access those funds for an emergency or to invest in another
property, you don’t have to reapply to the bank. You can simply withdraw it.
Using debt in this way can give you added flexibility so that you can respond to life changes.
Learn about debt
Get to know debt and it can become one of your best mates in investment. Shy away from it and you may miss out on a beautiful friendship.
Informed Investor’s content comes from sources that Informed Investor magazine considers accurate, but we do not guarantee its accuracy. Charts in Informed Investor are visually indicative, not exact. The content of Informed Investor is intended as general information only, and you use it at your own risk.
Informed Investor's content comes from sources that Informed Investor magazine considers accurate, but we do not guarantee its accuracy. Charts in Informed Investor are visually indicative, not exact. The content of Informed Investor is intended as general information only, and you use it at your own risk.