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

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%.

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.