On the 1st May 2012 the RBA cut interest rates by 50 basis points. What does this mean for the property market and investors? I honestly don’t know, however, for me it reiterated a conclusion I came to earlier in the week.
Now is the time to start paying down debt.
For most home owners this is a no brainer but for investors the idea of paying down debt is not too high on their priority list. The problem with this mentality is that the leverage investors once had through capital gains is no longer coming to fruition with the average property investor losing $2746 during the 2009-2010 financial year – this equates to a staggering $4.8billion dollars nationally according to a recent ATO taxation statistics release. While investors can claim losses on negatively geared properties they do so in the hope that over a period of time the value of their property will rise and offset any of the losses through equity and future sale prices resulting in a tidy profit. In uncertain economic times such as these can we really rely on the old saying that “property prices double every 7-10 years”?
Well…property prices may double every 7-10 years in the future but what if they don’t? Like any good business (and let’s face it investing is a business) you need to have a contingency plan. For some this will mean stocking up their portfolio with cash flow positive properties to offsets costs against those that are negatively geared in high growth areas and for others it will mean paying down debt.
This brings me to my light bulb moment from earlier this week.
I am a huge fan of Scott Pape, otherwise known as the Barefoot Investor, and on Sunday I just happened to be browsing his website when I came across an Extra Repayment Calculator. Out of curiosity I typed in my home loan details and an extra repayment of $100 a month to see what the result would be. These were as follows:
Loan Amount: $127k
Interest Rate: 7% – obviously subject to change over the life of the mortgage
Loan Term: 30 years
Payment frequency: Monthly starting immediately
Results: Time saved on loan = 8 years, Interest saved = $55k
Anyone who takes out a mortgage knows that over the life of the loan there is going to be A LOT of money paid in interest (as to how much, most people don’t want to know) so it was extremely interesting to see, in black and white, how much money and time could be saved by contributing an additional $100 a month. It got me thinking about how quickly I could pay off my property through extra repayments.
Here’s what happened when I typed in an additional $500 a month:
Results: Time saved on loan = 18 years, Interest saved = $119k
As you can see from the figures above, in 12 years I could own my property outright and save an astounding $119k in interest alone! Furthermore, if I were to make a simple adjustment in the repayment schedule changing it from monthly to fortnightly ($250) it would save me a further $3k and would knock another 4 months off the life of the mortgage.
On top of these savings there is also the added benefit of the property becoming cash flow positive a lot sooner which means more money in my pocket, instead of the banks, whilst still being able to claim costs against the property in terms of management fees, rates etc.
This obviously isn’t going to be for everyone however I encourage all of you to at least consider putting the “savings” you make from the rate cut back onto your mortgage. It’s amazing what a small amount of money can do over a long period of time.