Ask Paul: Should I pay a lump sum off my home or investment property?


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Hi Paul. I borrowed $296,000 two years ago to buy my own home.

After lots of extra repayments I have $111,000 remaining at an interest rate of 2.88% with $540 fortnightly repayments.

Ignoring offset, this would effectively be repaid in nine years. I also have an investment property with $271,000 remaining over 27 years at 3.09%.

paul clitheroe

I have $10,000 to make a lump sum repayment on one loan. According to a loan calculator, the lump sum repayment on my home would save $2794 interest over the remaining life of the loan, but it would save $12,498 over the remaining life of the investment loan.

We often hear it's best to pay non-deductible debt first, but is that always the case? In this situation, would it make more sense to pay $10,000 off the investment property? - Michael

Good question, Michael, and I am very impressed that you have done a solid analysis.

The key is here is the best result for you today. And this depends upon your tax rate. If you earn between $37,001 and $90,001, including the Medicare levy, you will pay 34.5% tax.

Your point about non-deductible debt is spot on. With your home, the 2.88% costs you 2.88%. But with the deductible interest on your investment property, your real rate is 3.09% less your tax rate.

So if you are in the most common tax bracket, the real cost to you of your investment loan is 3.09% minus 34.5%, meaning the investment loan is costing you about 2%.

This will differ if your income is higher or lower. Above $180,001, for example, you would pay some 48% in tax, making deductible debt even more attractive. So add one more number to your calculations: your tax rate.

Then I'd suggest you pay off the more expensive loan. Either way, I'd pay this into an offset account, if possible, giving you access to your money.

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Paul Clitheroe AM is founder and editorial adviser of Money magazine. He is one of Australia's leading financial voices, responsible for bringing financial insight to Australians through personal finance books, the Money TV show, and this publication, which he established in 1999. Paul is the chair of the Australian Government Financial Literacy Board and is chairman of InvestSMART Financial Services. He is the chair of Financial Literacy at Macquarie University where he is also a Professor with the School of Business and Economics. Click here to ask Paul your money question. Unfortunately Paul cannot respond to questions posted in the comments section. Please view our disclaimer here.
Sumit Kakkar
June 14, 2020 6.58pm

A good explanation and i always get confused. So if we fall on 35% bracket tgen as per above example, we shall pay home koan first as its coating 2.88 and investment costs 2% after tax deductions.

Steve Hollingworth
November 5, 2020 7.16pm

Hi Paul, I have $130,000.00 owing on my home and I am considering retirement in the next 12 months, I have a substantial superannuation (defined benefits) and $250,000.00 in savings. Would you recommend i pay off the mortgage prior to retirement. Love to hear your thoughts cheers Steve.

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