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Why We’re Not Paying Off Our Mortgage

August 1, 2022


Imagine you just bought yourself a home to live in for the foreseeable future.

It’s in the spot you want, and you can turn this house into a really liveable and comfortable headquarters for you and your family.

Better yet, let’s imagine you were somehow able to buy this home with cash!  No mortgage or debt of any kind.  You didn’t kill anyone for it.  You get to keep all your organs.  And you don’t owe Fat Tony a questionable favour at some unexpected point in the future.

Just you and this debt-free home.  Who in their right mind would alter such a sweet scenario?

Well, we did!  And in this post I’ll explain why.  What we’ve done is unusual, but it’s not as silly as it might seem at first.

 

A reminder of our unusual house-buying scenario

Earlier this year, I discussed how we managed to buy a home despite not having proper jobs anymore.  You can go back and read the full story here, but the short version of our plan was:

Step 1:  Buy a house with cash, by selling shares and using our large cash buffer.

Step 2:  Sell an investment property (IP) which we were going to do anyway.

Step 3:  Upon settlement of IP, transfer the existing loan to the home we had just purchased with cash (this is called ‘security substitution’ or ‘porting a loan’).

Step 4:  We receive the sales proceeds from the IP (after costs and some loan adjustments).

Step 5:  Reinvest this lump sum back into shares, and top up our bank account.

Step 6:  Continue monthly investing into shares and slowly selling down our IPs as per our plan.

Thankfully, we’re now on the other side after moving through all the steps!  So I’m now fleshing out some of the details on what this means for our situation and why we’re doing this versus sticking with a debt-free home.

 

Security substitution vs just selling our IP

As you might guess, we could have stopped at Step 1 and kept a paid-off home.  Then, with the proceeds of our IP sale, invest this money into shares, top up our cash, etc.

So why did we bother with the rest of these steps?  Two big reasons.

Reason 1:  By keeping the loan facility open, and transferring it across to our home, we get to keep almost the entire proceeds from the sale of our investment property.  That’s a shitload of money, to reinvest into shares and maintain access to and control over that we otherwise wouldn’t.

Reason 2:  Before reinvesting this huge chunk of cash, we’re able to pay down the loan facility to zero, then pull the money back out to invest it.  The outcome of that is the loan becomes tax-deductible because it was used for investment purposes.

Basically, we’re choosing to have a larger share portfolio and keep the debt, compared to the opposite.  The idea being we will earn a higher long term return from our investments than the interest we pay.  It’s the classic decision of whether you should pay off your mortgage or invest. 

Obviously, with interest rates rising, that calculation has changed a bit.  But shares are also cheaper which balances that out to some extent.   It’s still my view that, on average and over time, the after-tax return from shares is likely to comfortably exceed mortgage interest rates.

 

Debt recycling and tidying up our accounts

Thanks for the push from structuring expert Terryw who commented on my original house-buying post that I should probably look at debt recycling in our scenario.

Without going into things, I was hesitant to do so because it would’ve been rather messy with our previous accounts.   So, the best solution was to simplify our investing accounts by moving to a single joint account (to match our joint home loan).  This meant offloading the rest of our shares, but thanks to the market downturn, there was no capital gains tax.

In practice though, this means we had a very large pile of cash to invest/reinvest after the above process.   Funds from the property sale, plus our liquidated share accounts.

 

The biggest lump sum ever

Regular readers will know I like to invest our cash steadily over time.  So did we really invest such a big lump in one hit?

Well, yes, but not really.  Due to our bank we were only able to transfer $50k per day, so it still took a few weeks.   That’s a lot less scary than doing it all at once, but it’s still a speedy way to deploy cash!

To be honest, it wasn’t nerve-racking at all.  And while that makes no sense on teh surface, I think that’s due to two main reasons…

Lump sum investing stomach-calming reason #1:  A lot of it was reinvesting money we had only just taken out.  Our portfolio now is about 30% bigger than pre-house-purchase at the beginning of this year.

Lump sum investing stomach-calming reason #2:  The market was down 10-20%, so we were investing and increasing our portfolio at much cheaper prices (and yes, I’m very grateful bout that!)

In addition to this, I’m also approaching our ongoing cashflow slightly differently to before.

Did I take the opportunity to change anything with my portfolio?

Actually, no.  I basically replaced everything the way it was before, only bigger.   But there is a different type of change that’s worth mentioning.

 

Our cash situation.  From lots to little.

Regular readers might recall how our cash situation works.  I detailed it in this article, but until now here’s how we’ve been operating:

Sell an investment property.  Invest from this cash pile each month to grow our share portfolio, while covering other property expenses and our living costs depending on investment income and part-time work.

After a few years, sell the next IP and repeat the process, until we’re 100% invested in shares.

So what’s the change?  Well, after this latest property sale and lump sum investment, we’ve moved to being fully invested.

Why?  Well, our portfolio income and part-time is more than enough to cover our expenses, the remaining property outflows and have some cash leftover to invest each month.

Our part time income (mostly Mrs SMA, to be fair!), doesn’t seem to be disappearing, which is obviously very useful and hugely reduces the need for any sort of cash buffer as a backup.

If we decide to stop earning any sort of personal income whatsoever, we can just live off our investment income, and sell our remaining properties to get more cash while also removing a possible headache and risk.

Having less properties and more shares has reduced our outgoings and greatly improved our cashflow, which is fantastic and is the main reason behind this move.  ‘

Our cash now is about 1% of our net worth, which feels good after it being elevated for so long.  There are now three properties left, which we will probably offload in something like two-year intervals.

 

Final thoughts

The outcome of all this is:

We have a beefed up share portfolio that roughly covers our personal expenses.  We now have a tax-deductible home loan.  And we’re almost fully-invested and have very little cash.

It took a bit of fluffing around to get here, but the end result has been worth it.  Having said that, I’m sure we would’ve also been happy with a paid-off home and a smaller portfolio.

Well, I hope that all made sense!  Let me know if you would like me to elaborate or clarify anything and I’ll do my best.

To be clear, our house is still being paid off over time.  We could decide to pay if off early with future property sales.  Or we may even increase the loan later to invest even more.

Both options are attractive, so we’ll see what’s happening at the time and which option feels like the right move.  And that’s probably the greatest part of all… having options.

What are your own mortgage plans?  Destroy it as fast as possible?  Cruise along with regular repayments?  Use leverage to invest further?  Let me know in the comments.


32 Comments

32 Replies to “Why We’re Not Paying Off Our Mortgage”

  1. Thanks for the article! I own two units in Perth that I paid cash for, is it possible to detect recycle them I if I refinance and put the proceeds into shares?
    Cheers, Brent

    1. Hey Brent. Well, there is no debt to ‘recycle’, so the process is simply applying for a loan to use for investing in that case. And whether that’s feasible comes down to your personal income situation + whether the banks thinks you can comfortably service the loan amount you apply for. If you keep the debt modest and you have a decent income, I don’t see why that wouldn’t be doable.

  2. You have plenty of cash coming in, so makes sense in your situation.

    I have been paying extra off our mortgage and it should be paid off in full in next year and half. Having no mortgage payments means our savings rate will jump alot and also means we can earn less if we wanted.

    With this current uncertainty around it feels good to only have a small mortgage and a plan to have paid off.

    1. Wow congrats! That will be a fantastic situation to be in – a huge drop in expenses once that happens, which is extremely cool! Having a paid-off home is the perfect time to consider semi-FI or just winding things back a little 🙂

  3. Only today I’ve discovered that one the home loan is reduced, it’s very difficult to increase it again (or at least, it is wIth NAB) So all my big plans of increasing my loan size and merely debt reducing have gone out the window. I agree, keep the loan big even if you’ve got a heap of cash in there paid off – you can still access that cash if needed

    1. Ah yes, that can be an issue with reducing debt. Banks want to check all your details again even for a tiny increase. So there’s no redraw facility (or it’s restricted?) on your current home loan? If that’s the case, that sucks.

      As you point out, keeping the loan + cash offers greater flexibility. And it’s why people often choose to park lots of cash in an offset account rather than pay down the loan, even though it has the same happy outcome of reducing interest payments.

  4. Another interesting article Dave. I’m 48 and still have a $1mill mortgage. I have a good income but I’m so torn between investing and paying down the mortgage. I know I should pay down the mortgage but investing is way more fun particularly in a depressed market. I still haven’t got my head around the debt recycling and I’m not sure if it is appropriate at my stage of life?

    1. Thanks Chris!

      I would personally opt to attack the mortgage if I was in such a scenario. That’s because if it’s paid off by 60, then it dramatically reduces expenses at the same time as a super income stream becomes available and a pension is not all that far away (if no other investments are available).

      It also depends what excites you the most, and by that I mean what will motivate you to save as much as possible (being debt-free, or having a portfolio of investments).

    2. Why not do both? I was all for paying off our $700k mortgage in 7yrs with an extra $6k/m but found that by using the ING extra repayments calc, we’d be far better off paying $4k/m into the mortgage and $2k/m in ETF’s.

      Only extends the mortgage by 2yrs
      and pay an extra $40k in interest *but* by Year 9, we’d have paid off the house *and* own $250k+ of shares generating about $10k in distributions. By far the better outcome!

  5. Hi Dave, another great post. I have been paying off our PPOR home loan and only have 3 years (or less) to go. I’m not as courageous as you 🙂 Happy to pay this mortgage off and then increase the share investing.

    Looking forward to seeing what you do with the next IP’s and if you decide to pay off this mortgage.

    1. Cheers Pete 🙂 Awesome job on the mortgage too, very nice! It will be a great feeling when that payment disappears.

  6. Hi David,
    An observation to add, which is too late for you but may be relevant for someone else in similar shoes who wants to transfer shares from individual accounts to joint accounts: instead of selling the shares, withdrawing the money, transfering it to the joint account and then re-buying, you could have just done an off-market share transfer. What it means is that you transfer the shares themselves (so not cash) directly from your individual account to the shared account, so you don’t spend any time “out of the market”. From a tax perspective you still have to pay CGT, and it takes 1-2 weeks for the paperwork to go through, but it’s much simpler (e.g. you don’t have to transfer it in 50k increments)

    1. Ah yes, that’s a great suggestion, thanks for sharing! It’s outside of my realm of understanding, but I am aware of the possibility.

      I don’t think that would’ve worked in our case, as we had to use that money to pay off a loan, and then redraw to reinvest. But well worth mentioning for the benefit of other readers, much appreciated.

  7. Hey Dave, Interesting read.. In regards to changing anything in your portfolio you say you ‘replaced everything the way it was before’ – does this mean you went back to the LICs you had? Or are you still sticking with the simple VAS/VGS/REIT/QVE portfolio?

  8. Hi Dave, great information and post. I am interested in your comment “By keeping the loan facility open, and transferring it across to our home, we get to keep almost the entire proceeds”.

    Do you mean there are greater savings using security substitution? Is there any impact on CGT?

    For me pay of mortgage vs invest, depends on the loan amount. If the loan repayments are similar to market rent, then keep the mortgage and invest. If the loan is more than comfortable then pay down. 😀

    1. Glad you liked the post Mark!

      There is no impact on CGT for the property sale, as that is determined by purchase price and sale price less costs.

      The benefit is by keeping say $400k of loan facility open and attaching it to our new home (since it was debt free when we purchased), we then receive an extra $400k of proceeds from the sale of the IP, because otherwise the bank would normally take those funds to close off the loan and you get whatever is leftover. So there are no extra ‘savings’ as such, the upside is basically the returns you would get on the invested money vs paying off that debt. Which is why I compared the decision to the typical mortgage vs invest scenario.

      Hope that makes sense!

  9. Hey Dave,

    Since you originally had an IP that interest would be tax deductible, I just want to confirm that you have now turned your principal place of residence into tax-deductible debt due to using the redraw for shares?

  10. Great post thanks Dave.

    First time posting so sorry is you’ve covered this question previously…

    We are within $50k of having paid off our $1.5m PPOR (maybe $80k of redraw available) and are looking to move in the near future.

    We have a couple of IP’s but the largest loan is only $350k.

    We would be happy to buy a new IP and use it for short term rentals (preferably something we could also use occasionally for holidays).

    Could we do that and then use your transfer strategy?

    1. Hey Scott, thanks for the comment.

      You’re in an excellent position, so well done for that! In this situation, I’m not quite sure what purpose you see the loan transfer serving? What are you trying to do with it? In my case, it was to receive maximum sale proceeds from our IP sale so we could invest it. Are you selling an IP and hoping to transfer the debt to your current home so you can keep the proceeds?

  11. Hi Dave,

    Another good read!

    I understand from your pay down mortgage or invest article in 2020 you were all for investing and not paying down debt and even now you are still sticking to this which I admire.

    My question is if interest rates on home loans went beyond expectations and were sitting at 7-8% next year on home loans would your opinion change on your strategy or is the compounding to good to give up?

    Thanks,

    Damien

    1. Hey Damien, thanks for reading 🙂

      Excellent question. I think people forget that it wasn’t long ago that loan rates were 4% (in fact, when I first wrote that article I think mortgages were around that level). To be honest, I would probably start piling up cash if my offset could save me 7-8% in interest – that’s a very good tax free return. And then as rates came down again I would probably start investing it again.

      Having said that, if the market was down 35% at the same time, then maybe I would continue investing as the returns from those lower levels could still beat the interest rate. So it depends on the context and what else is happening at the time. Hope that makes sense.

      1. Yeah it’s alot to think about and I appreciate your thoughts. I’m fortunate enough to have a fully paid off PPOR at age 35 with my wife age 38. However over the past few months I have discovered borrowing to invest which could really boost me to fire! Will keep adding into our regular buying schedule. I think at the end if the year the picture may he alot clearer however markets could also rebound. It’s all an unknown! 🤷

        1. That’s fantastic on the paid-off home – you’re in a super solid position whatever you end up choosing to do!

  12. All these descriptions of debt recycling make my head spin, but let me see if I have a grip on it.

    We are empty nesters and our plan is to do the following. Sell our large family home and take out a mortgage (non tax deducible) to buy a smaller home. With the proceeds of the sale of the large home we will pay off the loan (apart from a small amount), and then redraw from the loan to buy ETFs, thus making the loan tax deductible. Is this debt recycling?

    1. Hi Alice. It does for me too, not exactly simple for most of us 😉

      Basically, yes that is one way to do it. Keep in mind you generally need to buy the next smaller home before you sell the old one, otherwise when you sell the first one the loan will close off and you’ll simply receive whatever proceeds are leftover (you can’t keep the proceeds if the bank no longer has a property as security). If this would be a large chunk, then another option is to keep this cash, buy the next home using a loan, then pay down that loan with the cash before redrawing and investing.

  13. Hi Dave,

    I wrote a reply earlier but it seems to have disappeared. So I will try again.
    We are empty nesters and plan to sell our large home and buy a smaller one. We are thinking of taking out a mortgage on the new home (not tax deductible). Then, with the proceeds of the sale of the old home we will pay off the mortgage (apart from a small amount). Then we will redraw funds from the loan to invest in ETFs, thus making the loan tax deductible. Is this considered to be debt recycling?
    Thanks.

  14. Is this article (August on mortgages) podcast as well? I’m having difficulty finding your podcast to search for it.
    Regards Louise

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