Author: Michelle Griffiths, Partner, Investment Advisory & Wealth
Everyone wants to reduce their debt. If you have both a home loan and an investment loan, which one should you pay off first? Michelle Griffiths explores the difference between the two options and what you should focus on.
It is quite common for home loan interest rates to be lower than loans for investment purposes (often around 0.5% different). It is natural to think that you should reduce the loan with the higher interest rate – but this is actually not the best thing to do in most instances. Let me walk you through the logic of this.
I like to talk about the fact that there is “good debt” and “bad debt”. Good debt is relating to loans for investment, which is tax deductible in nature (being that the interest is tax deductible). Bad debt is any loans that you have which are non-tax deductible as they are for the purchase of assets which are not related to investment or income producing purposes – for example, home loans, car loans, personal loans for personal expenditure items.
As a general rule you should always focus on paying off your bad debt first. Even though the interest rate on these loans may be less than those for investment loans, when you take into account the tax deductible nature of the investment loans – there is usually not much of a benefit in paying these off whilst you still have bad debt to deal with.
Let’s go through an example. If you wanted to pay $100,000 off a loan and you have a home loan which you are paying 2.5%, but you are paying 2.9% on your investment loan. Here is the difference between these two options:
| Home loan | Investment loan | |
| Net loan to pay off | $100,000 | $100,000 |
| Interest rate on loan | 2.50% | 2.90% |
| Interest cost | $2,500 | $2,900 |
| less tax affect (34% tax rate) | $986 | |
| Net interest cost | $2,500 | $1,914 |
| Net interest (effective rate) | 2.50% | 1.91% |
If you have any questions, please contact me on 03 9886 0800 or via email.
This article first appeared in ERA Magazine.
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Disclaimer: The information contained is general in nature. Professional advice should be sought before acting on any aspect on this page. Financial planning services provided by TAG Financial Advisors Pty Ltd (ABN 77 154 205 017 AFSL 415632), a wholly owned subsidiary of TAG Financial Services Pty Ltd (ABN 67 075 374 686). Copyright 2021. Please do not reproduce without the expressed written consent of the author.