Mortgage and/or unit trust

Question

I will be purchasing a property soon, so my question is the following:

Do I pay off my mortgage off as soon as possible (by paying more every month) or do I put the same amount extra into some unit trust?

This may sound like an easy question, as I am expecting the "You can't save when you have debt" response, however my thinking is slightly different here.

For arguments sake, the mortgage's minimum payment is only 30% of my salary, over the years that percentage will drop, ie in 5 years time, it will only be 20% of my salary.

And to top that off, the value of money depreciates over time(thus they have the interest rate, etc), so if I had to pay 5000 units per month now, in about 10 years 5000 units will be less worth to me.

So which way is best to pursuit?

At the moment, the mortgage would be over 20 years at a ridiculous interest rate of 9.0% (on average our bond interest rates in South Africa are between 8.5% - 12%)

Answer 1

I doubt you will get an answer equal to "You can't save when you have debt". Because most mortgages are for decades, very few people would be able to save for retirement if they had to wait to be mortgage free. The difficulty in saving occurs when the interest rate is very high (18% or more) and the interest is not deductible. Such as with credit cards.

The minimum payment for your mortgage is 30% of your income. If that doesn't include taxes and homeowners insurance in the 30%, then for the United States that would be considered too large. While the general plan to pay down the mortgage is a good idea, make sure that you are able to handle the minimum payments before starting to increase the payments. Try the minimum for a year or two before getting aggressive

The calculation is based on the interest rate of the mortgage, the interest rate of the savings account, and the potential tax deduction of the mortgage and the tax rate on the earned interest. Putting extra money into a mortgage, but missing out on matching retirement money would also have to be figured into the calculation.

Make sure you do save for retirement , kids education, and emergencies. Unless your country has a complex system where the money can flow in and out of the mortgage, then once you put extra money into the mortgage you can't get it back when the car dies.

The nice thing about putting extra money into a mortgage is that you can do it either in an organized way, or only when you feel comfortable. So it is not urgent for you to commit to a plan immediately. One thing to avoid is a plan that charges you a fee to add extra money, or charges a fee to switch to a bi-weekly mortgage. While your ideas is good, these plans should never cost any money to start, and may be a scam if a 3rd party gets between you and the lender.

Answer 2

The answer can depend greatly on whether the interest on a mortgage for the house you live in is tax deductible in the country you are in (I assume the mortgage is on the house you live in and not an investment property).

It will also depend on the difference between the mortgage interest rate and the return of the unit trust, your income and your tax rates.

In essence you would need to do a cost-benefit analysis to figure out which option would provide the bigest financial benefit, considering the different rates, your income and your tax rates.

Basically, if you can get a better return from the unit trust than the mortgage interest rate and you can claim a tax deduction for the mortgage interest payments, then you may be better off investing in the unit trust rather than putting extra repayments into the mortgage.

Answer 3

The answer is mathematics.

Let's say you have $100 capital to invest with..

With a mortgage:

• You can buy a property worth $500 with your $100.
• Growth occurs on $500 instead of $100.
• You pay interest on $400

With a unit trust (assuming you don't put in borrowed money):

• You buy $100 share with $100.
• Growth occurs on $100 only
• You pay a X% to the trust as a fee.

5% growth on the property is $25, but a $25 profit on a unit trust requires 25% growth. Well, that's assuming zero interest and zero fees.

Let's say interest is 3% but so are trust fees. A property now requires 8% growth for $25 profit in a year, where a unit trust now requires 29% growth for $25 profit. Which one is more likely?

The above calculations don't take in to consideration all associated costs and is obviously exaggerated but it shows the answer is not black and white but is instead just mathematics on a bunch of variables.

Debt isn't a bad thing so don't be afraid of using debt. With debt you can borrow more to invest. Having a fully paid off house is not a good investment if some of that equity could be earning you more else where (if the math makes sense).