Paying off the mortgage on your own home is one of the biggest goals for a lot of New Zealanders.
In most cases, people purchase their own homes with a 30-year loan term and pay this off gradually over this time. It's a reliable way of paying off your own home, but surely there is a better way?
There are plenty of strategies to pay off your own home faster and we will explore one in this explainer. Of course, the most important thing is to have a plan. Know what you're trying to achieve and work towards that goal.
Most banks offer a loan with a 30-year term, meaning you have 30 years to pay back the loan you drew down.
This means you are being charged interest on all the borrowed money so the longer you take to pay it off, the more you're paying in total interest costs.
The goal for most homeowners is to reduce the amount of interest they're paying and the best way to do this is to fully pay off their home loan as fast as they can.
Some mortgage brokers will give advice on how to do this by using revolving credit facilities etc. and this is all really good advice. However, one of the most effective ways to pay off your home loan faster is to purchase investment properties.
This might seem counter-intuitive to start because you're taking on more debt, but there is a logic to it.
The graph above might look complicated, but it is actually quite simple.
Essentially, by building capital gain on your investment properties over several years, you will (at some point) get to a point where your outstanding home loan is equal to the capital gains in your investment properties(s).
At this point, you can sell the investment property and use that equity to pay the balance of your mortgage outstanding on your own home.
There is no prescribed formula for working out when your capital gains and the principal loan amount will intercept but when it does, you can liquidate the asset and use the funds to pay off the mortgage on your own home.
Purchasing investment properties can accelerate paying off your home loan
Let's consider an example of how this might look:
Assume a couple bought their first home 4 years ago and have $500,000 left outstanding on their home loan, this means their loan term is likely to be 26 years (30 years - 4 years).
Based on this, we can calculate their monthly payments using a 5% interest rate.
Once we know this, we can use an amortisation calculator to work out how much of their monthly mortgage goes towards interest payments and how much goes towards principal payments.
If the couple now bought a $700,000 investment property and which was forecast to have 5% capital gains annually, we can work out where we expect the equity & loan balance figures to intercept.
In this case, the interception point is about $440,000 OR 68 months which is 5yrs 8 months. At this point, if the assumptions stayed true, this couple could sell their investment property and use the equity to pay off their home loan in full.
This strategy is likely geared towards people getting close to their anticipated retirement age because it does rely on selling off your asset.
For people with a significant portion of time left before their anticipated retirement age, their focus would likely be on highly leveraging their portfolio and investing in as many properties as the bank will allow them to.
In that case, there is a lot more time for the investor to build their wealth (through capital gains) so paying off their own home loan is easier and something they might not consider doing until later down the track.