Do I pay my debt down in a low interest rate environment or borrow more?

By Steve Marsten

Many Australians face a heavy debt burden and they often faced the dilemma of whether to pay down debt with excess cash or to invest that money in an attempt to turn it into even greater amounts of wealth. The issue is - If you pay off too much debt and reduce your leverage, you may not garner enough assets to retire. Conversely, if you're too aggressive, you may end up losing everything. So to decide whether to pay down debt or invest, you must consider your best investment options.

I always believe your decision should be based on your after-tax cost of borrowing versus your after-tax return on investing. Suppose, for instance, that you are a wage earner in the 32% tax bracket and have a conventional 30-year mortgage on an investment property with a 5% interest rate. Because you can deduct the mortgage interest from your taxes, your true after-tax cost of debt is around 3.4%. So if you are not receiving a return greater then 3.4% after tax, on your investment, consider paying down the loan asap!

Further, private home loans don’t usually have tax benefits to the average taxpayer and in a falling property market many are often losing money. Hence the smarter option is to pay down this loan as soon as possible. This is especially true if the interest rates are low in the economy.

In this day and age it still amazes me that there are homeowners who are paid weekly (or even fortnightly) but continue to pay the home loan off monthly. You literally take years off the loan if you multiply the 12 annual payments by 12 months and divide it by 52 weeks to obtain your weekly commitment and begin paying weekly. If you can then round up amount by $20 or $50 or even $100 – that time frame contracts incredibly. Clearing your debt is a plus and given that you don’t realise a loss unless you actually sell your asset, it allows time for the asset to recover its value.

At Sothertons we are always assisting taxpayers and investors to get ahead with debt control strategies and investments. Call us on 49721300 for more information.