Pay down that debt to get ahead
Here is the key to unlocking your prosperity potential - and it's not glamorous: paying down debt is pretty much the top strategy to building wealth. Using your money to do this is often even better than buying shares or investing in property.
You may be thinking that's a big call, but consider this:
Any money you use to reduce debt effectively earns a return equal to the interest rate you are being charged.
So if your mortgage interest rate is 6 per cent, any extra money you put towards it "earns" 6 per cent.
Better still, this return is not only risk-free but also tax-free (because you are not actually earning that amount, but saving yourself from paying it).
You can expect long-term returns of no more than 7 per cent a year from the sharemarket (and less in some recent years). Alternatively, you could save, say:
■ 16 per cent on any credit card debt.
■ 10 per cent on your personal loans.
■ 6 per cent on your mortgage.
Even with mortgage rates at record lows, and sharemarket returns seemingly on the up, a higher-rate taxpayer would need to earn a nearly 11 per cent annual investment return to equal the benefit of directing money into a home loan with an interest rate of 6 per cent. And as soon as mortgage rates climb again to a more average 8 per cent, the return necessary to come out ahead leaps to 15 per cent.
Here are my golden mortgage rules - to get you in and, crucially, out of debt fast.
■ Never borrow an amount that means your repayments are more than one-third of your before- tax salary.
To be super safe, you should keep it to one-third of your salary if interest rates were to go up a full percentage point.
And strive for a 20 per cent deposit, both for a price dip buffer and to avoid paying lenders mortgage insurance, if at all possible.
■ Check whether you qualify for a professional package. A professional package gets you an interest rate discount of up to a full percentage point on the standard variable rate. So rather than wait for the Reserve Bank to announce a rate decrease, you could give yourself the equivalent of four whole cuts - as early as today.
■ Fix your rate only if three conditions are met: one, interest rates are expected to go down; two, lenders are fiercely competing for your business; three, you can get a fixed interest rate significantly lower than the variable rate. Even if you judge this is the case now, only ever fix half your mortgage and for a maximum of three years only - a lot can happen in that time.
■ Because any negatively geared investment means money out of your pocket, never overextend yourself, and enter into such an arrangement only if you think the prospect of a capital gain is good (so you stand a chance of getting your outlay back).
■ Resist dipping into the equity in your house for depreciating assets or lifestyle expenditure, such as holidays. Repeat after me: My mortgage is not a slush fund; it is the main source of my future financial security.
■ And here is the once-in-a-lifetime opportunity: if interest rates go down, keep paying the same amount. Unless you are having real trouble making ends meet, you should only ever increase your mortgage repayments. Interest rates are at record lows but if you just maintain your repayments at their level before the most recent rate cut, you'll save $22,952 on the average $300,000 big-bank mortgage - and clear your loan one year early.
Keep repayments the same and also move from the big-bank average rate (nearly 6 per cent) to the best rate (about 4.5 per cent), however, and your saving leaps to $66,755 and six years. For no extra outlay.
This is an edited extract from The 12-Step Prosperity Plan, to be released exclusively on themoneymentorway.com next week. Nicole Pedersen-McKinnon is a Money columnist and ambassador for MoneySmart Week.