Prioritise paying off the mortgage before buying again

IF YOU’RE smart you will make paying off your home a priority before you buy an investment property, writes the Barefoot Investor.

The Barefoot Investor says if you don’t have any significant Australian income, because you are living and working overseas, then negative gearing is a terrible strategy.

LIZ ASKS: We have moved to Dubai (yay, tax-free income). In six months, our first investment property in Australia, worth $230,000 according to the bank, will be paid off. We plan to come back to Australia in March next year to buy another property. Should we buy another low-value but positively geared investment similar to the one we have, or should we go for a negatively geared CBD apartment in the hope of a capital increase?

BAREFOOT REPLIES: If you don’t have any significant Australian income, then negative gearing is a terrible strategy (because it works by giving you a deduction on your income tax). Basically, you’d be taking all the risks a “normal” negative gearing strategy delivers but with only half the reward, that is, no tax benefit. Worse than that, if you’re non-residents in Australia for a period of time, you may not even benefit from the 50 per cent CGT exemption when the property is eventually sold. All up, your best investment (once you’ve paid off that property) is to diversify your investments into owning the world’s best businesses.

PAY OFF YOUR LOAN

TOM AND RACH ASK: My fiance and I live in a large regional centre. We have a family home on a 30-year loan, which we are on track to owning in 12 years. We are now thinking of buying an investment property in an improving area — a two-bedroom unit for about$120,000 returning $170 per week. The thing is, in our town the real estate market does not grow quickly, so there are slow capital gains, though rental properties can yield 6-7 per cent returns. Thoughts?

BAREFOOT REPLIES: That “6-7 per cent” is the gross return, let’s look at the net.

If your property is rented, say, 48 weeks a year (unlikely for a two-bedroom unit), you’ll bring in $8160 in rent.

From that, deduct your loan repayments, agent’s fees, rates, land tax, maintenance, body corporate fees, depreciation, accountant fees … need I go on?

In a good year, you might break even.

In a bad year — when the hot water cylinder blows up and your tenants go AWOL — you’ll lose money. If you lose money, you’re relying on capital growth (selling your house for more than you paid), which, as you say, doesn’t happen quickly in your area. And if interest rates rise, can you put the rent up? Probably not.

If you’re on track to own your family home in 12 years, you could probably bring that down to eight by concentrating on that, not on being
a landlord. When you don’t have a mortgage payment, you can really
build wealth.

SECURE YOUR RETIREMENT

DONNA ASKS: I am a recently separated woman of 50. After settlement, I might get about $140,000. First, what are the chances of me getting a loan at this age? (I earn $70,000 a year.) Second, if I do get a loan, am I better off buying two smaller investment properties to rent out or one to live in?

BAREFOOT REPLIES: Fifty is the new 40. You’re still young, though a bank will look more closely at your ability to pay a loan than with someone younger.

What’s more important to a lender, though, is having a secure income and a decent savings history.

Assuming you’re planning on working until retirement age (which is 67 for you), you have 17 years to repay a mortgage. That’s totally achievable, given you’ve got a very healthy deposit. I’d ditch the idea of buying two smaller properties. Instead, buy a home for yourself and make getting rid of the mortgage ASAP your priority.

If you want a tax-effective way to secure your retirement (which you also need to do), start salary-sacrificing into super. Yes, that’s going to be tight on your income, but plenty of people have bought a home, and topped up their super, on much lower salaries.

WORK HARD, EARN HARD

MAX ASKS: After losing my engineering job last year, I have been working multiple part-time positions and taking occasional work opportunities when they arise. I am in the same position I was at university, with one job taxed at the normal rate and all other “second jobs” taxed at a much higher rate. What is the government’s rationale for taxing additional income like this, and is there any way around it?

BAREFOOT REPLIES: One day, a bloke who didn’t want to take a second job, and instead wanted to spend his weekends drinking frothies at the 19th hole, gave this excuse to his wife: “Love, why would I bother working a second job … I’ll lose it all in tax.”

And from that point on it became one of Australia’s great urban myths.

So let’s clear it up.

Whether you work one, two or 20 jobs, the same tax scale applies.

Most people nominate one job to claim the tax-free threshold on (in fact they can claim the threshold from more than one job if their total income is below $18,200). And it simply makes sense to claim the tax-free threshold from the highest-paying job. This is good news for you because you now work as you want, and you know that you won’t be penalised. Do the work, earn the money, pay the tax.

SAVE HARD FOR A HOME

TROY ASKS: I am a 25-year-old guy and I have worked in the mining industry for almost seven years. Instead of buying property, I bought shares and a small business, which I paid for upfront at a cost of almost $100,000. After nine months, I would like to take my minimal savings and get involved in the property market. I have seen companies who say they can get you into property for as little as $25,000. Would you invest in one of these companies?

BAREFOOT REPLIES: Strewth! I had a look at one of those “gurus”.

He brags that he retired at 24 and owns 200-plus properties — and has a pictures of himself in front of his Bentley to prove it.

Look, these guys are property spruikers who either charge a fee or cop a commission when you buy a property.

So, the lower the financial bar they set, the more potential customers they get. Troy, if you purchase an investment property when you have minimal savings, the closest you’ll get to a Bentley is washing one.

Originally published as Prioritise paying off the mortgage before buying again