Should we take on more debt now to be better off later? 

Women with CentsBlog, Debt, Investment, Mortgage

This week I’m answering a community question from a fellow Women with Cents looking to take on some additional debt…

My partner and I both have one investment property each which we are paying principal and interest on, and have separate bank accounts, with all our savings in our offset accounts. As they are relatively new loans, both properties are quite heavily negatively geared, although they both have good tenants.  

We are thinking of taking on a third mortgage together which would be the house we live in. Do you think it’s better to switch both our investment property loans to interest only and put any extra savings into our third home loan, or to pay principal and interest on all three loans, as long as we can afford to? We hope to hold our investment properties for as long as possible, in order to offset our tax, and to hopefully make capital gains in 10-20 years. Thanks for your advice!

First of all well done on investing to grow your wealth! There’s a bit to cover here, so I’m going to break up my answer into three parts.

1. What’s better: interest only, or principal and interest, on investment properties?

Providing you also have a mortgage on your home, most advisers recommend keeping investment properties on interest only repayments and using the spare cash to pay down your mortgage. The reason for that is there can be a tax benefit associated with the debt on your investment properties, but there is no tax benefit on a loan on the house you live in.  

Where you have any spare cash, you can either put it directly on the mortgage or offset account of your home (if you have one, to pay down that non-tax deductible debt sooner) or, in the investment property offset so that if you do use that cash towards a deposit on a home in the future you have not made a negative impact to the tax deductibility on the investment property. 

2. More debt or more savings?

You mentioned you are very negatively geared, so I am going to assume that there is not much equity in your investment properties. If that is the case, be careful when buying your home not to over extend yourselves.

I advise most people to build a buffer of three months’ emergency expenses (adding a couple of months of mortgage payments per investment property) and also look at your life insurances like income protection and trauma cover. However unlikely you think it is, its important to be prepared for the worst case scenario. For example, imagine the perfect storm of rising interest rates, both properties being vacant, and you or your partner being out of work or off sick for an extended period of time. The last thing you want is to be forced into selling one or all of those properties (and risking selling at a loss).

Put yourself in the best position to ride through any storms, and also make sure you can afford repayments at a rate of 6-8%.

3. Negative gearing – is it negative or positive?

Holding onto the properties and making a capital gain is great, but keep in mind that negative gearing means you are losing money on that investment. So when you sell it, in order to make a profit, you need to not only make a profit on the purchase price, but also factor in the thousands of dollars of losses you incurred each year along the way.  

Depending on the age of the properties and how much you can claim in depreciation it wouldn’t hurt to consider (once you have your own mortgage under control) paying down the debt on the properties so that they become cash neutral and the only loss is depreciation “on paper”. Negative gearing is a sexy concept but it’s not always all that it’s cracked up to be. 

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