With rates for a new home loan as low as 3.5%, the long term interest savings on reducing your mortgage are considerably less than the returns on investing a commensurate sum in a portfolio that might return 10% or more over the same period. (UGC has historically returned 15%-18% for investors, so 10% is a fairly conservative ballpark figure for calculations and comparisons.)
For example, any graph of a 30-year mortgage demonstrates how long it takes the amount of debt to dip at the beginning, but how the amount of debt declines more rapidly over the period, accelerating particularly in the last few years of the loan.
If you had regular monthly savings to pay into the mortgage, you might see that acceleration happen earlier but the fact remains that if you insist on paying your mortgage off early before investing elsewhere, you cut short the time you have for really effective compound returns.
Assuming as a best-case scenario your home loan can be paid off early while you’re in your mid-50s, this leaves only around a decade to build up assets that will support you into retirement.
Investing steadily for 30 years can build your assets from zero to potentially a million dollars or more at the end of that period. Just like the reduction of a loan, the steady investment of savings into assets results in the investment providing compound returns that accelerate through the years.
30 years of reducing debt versus 30 years of building assets have very different financial results. Take, for example, a monthly surplus of $1000. Paid into a home loan, at the end of 15 years, you’ll have paid an extra $180,000 into your loan and saved around $60,000 in interest.
However, if you invest that monthly surplus in an investment portfolio with a return of at least 10% per annum, at the end of 15 years and after-tax, your return will be around $281,000 – $180,000 of your own investment funds, and a further $101,000 income.
This income has tax implications of course, but debt recycling offers ways to manage that, through using tax-deductible investment loans as part of your strategy.
Basically, if you have the capacity to save, don’t wait till you’ve paid off your debts before you start accumulating assets, so you can give those compound returns time to really start performing.
Debt repayment is a fairly safe option for those who don’t know much about investment, which involves more unknowns for the average person. Don’t let that put you off – the world is full of people no different to you, who are successful with their finances: because they took the time to acquire the knowledge that takes them out of their financial comfort zone.
Louis will share more tips on using debt to your advantage over the next few weeks in our podcast, The Investor Exchange.