Ask Paul: Should I consolidate my car and home loan?
Q. I'm a very big fan and enjoy reading Money magazine. I hope you can help me with this question.
I'm 26 and earn $83,000 a year, whereas my wife is 25 and earns $55,000.
We own a home, which we are using as an investment property and as a result of this, we are living with our parents for some personal reasons.
At the moment, the investment property which will be our future home, has a loan of $575,000 with a variable rate of 4.9% but is worth $750,000. We have a car loan worth $55,000 with a fixed rate of 6.9% for 5 years with no other debts.
We also have $55,000 in our offset account and can save anywhere between $1500-$2000 a month. I pay for everything on my credit card and pay the balance off when it's due so I keep as much money as possible in the offset account.
My question is should I keep paying the car loan at an interest rate of 6.9% fixed for the next five years or consolidate the car loan with the home loan so I have a variable interest rate of about 4.9%?
Also, with that $55,000 in our offset account, is it better kept in there or investing a portion in a managed fund, and/or use those funds along with the equity in our house to purchase an investment property?
My wife and I do intend on moving into our home in July next year and need about $25,000 for renovations. During this time, we plan on having our first child. - Danny
Hi Danny, I am most impressed. Financially things are going well for you, but what is really great is that you can articulate your short- and medium-term goals very clearly.
It is clear to me that people with goals have a much better chance of success with not only their money, but in their lives overall.
So, a good start. Living at home and using rent and negative gearing on your property is a terrific plan, providing of course the obvious stresses of living with parents and in-laws is manageable for all concerned.
That bit I'll leave to you.
A lower cost of debt is always better. Providing there is not a penalty greater than the interest savings, I am very happy for you to consolidate the car loan into your home loan at 4.9%.
While you are at it, have a chat about your interest rate. 4.9% is OK, but not brilliant.
Your lender may not want to play while it is an investment property, but once you move in, the best mortgages are much closer to 4% than 5% and I think you can do better here. Remember a 0.5% saving on your interest rate lowers your repayments by around $2900 a year.
Better you make that money and not your lender.
Where I am not happy is the idea to gear up further and buy an investment property. Sure, you have good equity in your current property and $55,000 in your offset account, but the fact is your total debt is, including the car loan, $575,000. You are good savers and can put about $2000 a month aside. But in my view a new investment property and a baby are going to be a poor match.
Realistically, your wife may not get back to work for some time and it is much smarter to assume her income when she returns is, at best, part time. This means your savings capacity may disappear, in particular when the costs of a baby are added.
If you were going to wait say 5 years, then I think the property could work.
But deferring a family for an investment property is a poor call. At the end of the day, it is health, family and friends that count. The truth is most of us will die too rich, so don't defer family for more money down the track.
So my advice is pretty simple. If a baby is firmly in your plans, as it seems to be, I would suggest you concentrate on pouring your savings into your offset account. Even if the car is at your home loan rate, do have a plan to pay it off in no more than 5 years.
I appreciate you are paying the money to yourself via your mortgage repayments, but a car is not going to last the 25 years or so that your mortgage may run for.
Importantly, if you do refinance the car into your home loan, have a chat about a lower rate. Also, put the car repayments into your offset account. You want to keep your mortgage as high as possible and direct any surplus into your offset account.
If you move one day and want to keep the existing property as an investment property, you want the highest possible mortgage on the investment property and to take a big offset balance to buy a new home with a low mortgage.
Pretty obviously a home loan on a property you live in is not tax deductible and an investment property loan is. The rule here is very clear. Have the lowest possible debt on your home, and the most on investment property loans.