Should you be buying shares or paying down your home loan debt?
Here’s an interesting situation for you to consider.
I’m working with a new client who saved $300,000 to invest. Feeling they did not know what options were available to them, they sought advice from another financial planner on where to invest their savings.
The financial planner was authorised by a well-known name in the industry.
Accordingly, their savings were invested in a combination of managed funds on a wrap platform (a wrap platform is an online administration service that holds the investments for you, provides performance reporting capabilities and prepares the annual tax report).
This client also has a $600,000 non-deductible home loan.
At the current interest rate of 4.50 per cent the loan has principle and interest repayments of $3,493 per month.
To pay off this home loan over the next twenty-three years, my new client will have to make total loan repayments of $964,158 back to the bank.
They are on the second highest marginal tax rate.
Therefore, they will need to earn $1,593,650 over the next 23 years to have enough income after tax to pay back $964,158 to the bank for the $600,000 that is currently owed on their home.
I’m angry because there was no advice given to pay off the home loan first because the adviser was paid on the amount of funds under management they look after rather than being paid for giving strategic financial advice.
This is what I would have recommended:
Use the $300,000 to reduce the home loan debt.
The monthly principle and interest loan repayment reduces to $1,747.
Over the next twenty-three years, the client will now only pay $482,079 back to the bank.
This will save a massive $182,079 in non-deductible principle and interest home loan repayments.
They will now only need to earn $796,825 before tax to pay off their home loan.
With the new equity in the home, we may use this as a deposit towards an investment property or to draw new debt and purchase a diversified investment portfolio.
If we were to redraw $300,000 to invest in the exact same investment portfolio all the loan repayments would be tax deductible.
The end position would be very similar. My clients will still have a $300,000 investment portfolio.
They will still have around $600,000 debt.
The significant difference is that half of that debt would now be tax-deductible because my clients have halved their non-deductible principle and interest home loan repayments.
This is just one example of how strategic financial advice can benefit a client.
A good strategic financial planner will not charge a fee for funds under management.
If your financial planner does charge a fee based on how much they manage for you and you still have a non-deductible home loan, it’s time to seek new advice elsewhere.
With such a strategy, if you are changing the use of your debt from paying off a home to funding investments, you need to feel comfortable that such a strategy is appropriate for your circumstances.
There may be a risk at some point in time that the volatility of a diversified investment portfolio may be worth less than the loan you owe to the bank.
Like all strategies, it is important to properly work out the cash flow implications and understand what risk you are taking on.