Written by Dan McFerran of
www.themortgageformula.com
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Creator of The Mortgage Formula. After working in the financial industry for over 20 years, for major banks and as a licensed financial planner, the author created The Mortgage Formula to help "Mum's and Dad's" pay off their mortgages quickly and easily w
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We’ve been trained to think in terms of risk vs reward. Low Risk = Low Return, High Risk – High Return, but what if you could have the best of both worlds?
This information alone is worth hundreds of thousands of dollars over your lifetime and you’re reading it now for free. I used to charge people thousands to advise and implement this strategy and they loved it. But anyone can do it, and the best way to do it is to set it on auto pilot. I’ll show you how right now.
Option 1
Let’s say you have $20,000 to invest and want a decent, low risk investment. The best I could find today, in Australia was around 3.80%pa. OK not so bad...however the current core inflation rate is 2.3%. So for your $20,000 to buy the same amount of goods and services next year needs it needs to increase to be $20,460 ($20,000 x 102.3%). Assume that I’ve just earned 3.80% on my $20,000 which gives me $760 to include in my taxable income for the year. Based on a average tax rate of 40% , that leaves me with $456.
Wow... I just lost $4 by having my money “invested” in the bank.
Option 2
So let’s look at another option. I have a $235,000 mortgage with XZY Bank Ltd and my interest rate is 4.5%pa. I decide to check if my bank allows a fee free redraw on any extra money I contribute to the loan. They confirm with a YES you can. So, I now invest the same $20,000 into my mortgage reducing the loan to $215,000. Firstly, when they calculate interest, they generally do it on the daily balance and charge it monthly. So the first benefit is that when you make your next mortgage payment, you will make greater headway into reducing the principle outstanding amount by being charged less interest. Fantastic!
Annual Effect
Let's look at the annual effect of just the $20,000. So we get $20,000 x 4.5%pa = $900 that you’re not being charged on your mortgage by your bank. This is like earning money on an investment but you don’t pay any tax. That’s right...to compare this investment, apples for apples, you’d have to gross up the $900 by your rate of taxation. For me, I’d have to invest and earn $1,500 ($900 divided by 0.6) to match the after tax return of putting it into my mortgage. The equivalent return is 7.5% pa as shown here:
Principle amount
$20,000
Annual rate of return
7.5%
Return in dollars
$1,500
Tax (at 40%)
$600
Remainder
$900
Inflation
$460
Net
$440
So, even if you were to put the money in your mortgage for 12 months, you’ve managed to retain your buying power of the money and add $440 to the amount. That's a win, and its gets better the longer it’s left there!
