I've seen many situations where someone will have their mortgage nearly maxed out, yet they will have 50% equity in their investment property, as they feel that they want to own their investment. What they don't realise is that this could end up costing them tens of thousands of dollars over time.
Let me summarise it like this: if you have personal debt and investment debt, and the interest rates are within one or two percent of each other, then you should always have your investment debt maximised and be working to reduce your personal debt.
The reason? The investment debt is tax deductible, whereas the personal debt is not.
Let's say that you have two properties, a home and an investment property and a combined debt of $200,000 and the value of the two properties combined is $500,000. In this case, you would want to have the entire $200,000 debt against the investment property and none owing on your home. This will leave you with a Loan to Value Ratio (LVR) of about 80% on the investment property, which is usually the maximum that a lender will provide without lender's mortgage insurance.
You are therefore maximising your tax deductions as all of the interest on the loan is now tax deductible, potentially increasing your tax return by $10,000 (the interest on the loan). If you had 100% of the debt owing on your home, then you would get no tax deduction at all! This means by organising your debt to be more efficient can save you tens of thousands of dollars per year!
So if you have personal and investment debt, make sure you are borrowed to the limit on your investment debt and are reducing the personal debt as much as possible. When you no longer have any personal debt, you may consider starting to pay down the investment debt, or simply accumulating more assets, depending on your age/goals etc.
I hope you enjoyed this post, please share it on Facebook and Twitter and follow me @EarlyRetireAus send me an email at earlyretirementaus@gmail.com and leave a comment!
Peace! E.
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