Author Topic: Can someone with better maths than me check my calculations please?  (Read 2952 times)

island_guy

  • 5 O'Clock Shadow
  • *
  • Posts: 17
Hello

This question relates to the classic 'pay off mortgage or invest' query but with specific calculations behind it.

By my calculations I'm worse off investing (on a pure monetary basis regardless of other factors such as ready availability of cash etc).

I would be grateful if someone with a larger brain than me could check my calculations and let me know if I'm missing anything.  Many thanks!

Background

I have a property in a country I no longer live in with an outstanding mortgage of 265,000.  My interest rate is 4.78% (this is the lowest rate available in this country for a buy-to-let mortgage.

I do not live in this country or earn any other income in this country.

I rent the property out for 1,250/month (i.e. 15,000/year).

Other than a 2,000 tax free allowance all rental income is taxable at 20%.  However, you also get a deduction for mortgage interest paid.

I have 50,000 in savings (in addition to an emergency fund) which I am deciding what to do with.  Before considering other options which may lead to higher returns, I have found an 'instant access' savings account yielding 3%/year.  The marginal income tax rate in the country I live in is 15%.

Scenario 1 - Pay off mortgage

265,000 - 50,000 = 215,000 mortgage
215,000 mortgage = 10,191 interest.
13,000 potentially taxable rental income (15,000 - 2,000 tax free sum).

13,000 - 10,191 as a deduction = 2,809 taxable rental income

= 561.8 income tax bill for the year.

Scenario 2 - Invest

265,000 mortgage
265,000 mortgage = 12,561 interest
13,000 - 12,561 interest = 439 taxable rental income.

= 87.8 income tax bill for the year.

= 474 less in income tax.

+1,500 interest from the savings account (-15% tax = 1,275).

BUT:  2,370 more in interest.

Therfore: 2,370 - 1,275 - 474 = 621 worse off a year.

What do you think?

MDM

  • Senior Mustachian
  • ********
  • Posts: 10740
Re: Can someone with better maths than me check my calculations please?
« Reply #1 on: April 02, 2015, 12:38:04 AM »
...mortgage... interest rate is 4.78%.
...savings account yielding 3%/year.
Distilling the OP down to the essentials: yes, paying off a 4.78% mortgage is better than investing with a 3% return.

GuitarBrian

  • Bristles
  • ***
  • Posts: 252
  • Age: 32
  • Location: Panama
Re: Can someone with better maths than me check my calculations please?
« Reply #2 on: April 02, 2015, 12:58:32 AM »
My first thought is... The cash flow is pretty bad. In fact, it is almost certainly negative after taxes, insurance, and maintenance.

That said, I would suggest selling the property. Even if you did still live in the country, but, doubly so since you do not. (Unless you are not physically far away, ie Europe and you're just across a boarder etc.)

Since that isn't what you asked... ... ...


You basically sum it up at the bottom. 621 difference at a cost of pouring your 50,000 into the property. If that is worth it, then you have your answer, if not, then you have your answer.


I punched the numbers into the mortgage calculator... You seem pretty much right on. One thing that did stick out, was the 50k extra payment lowered your overall interest paid by over 110k. Plus 10 years sooner payoff date. Assuming you don't make any additional lump payments/extra principal reduction. I also don't know how many years you have paid etc. Those numbers assume a 30yr @ 1387 a month.

marty998

  • Walrus Stache
  • *******
  • Posts: 7310
  • Location: Sydney, Oz
Re: Can someone with better maths than me check my calculations please?
« Reply #3 on: April 02, 2015, 01:19:14 AM »
Investing in a savings account is not really investing though....

My first thought is... The cash flow is pretty bad. In fact, it is almost certainly negative after taxes, insurance, and maintenance.

That said, I would suggest selling the property. Even if you did still live in the country, but, doubly so since you do not. (Unless you are not physically far away, ie Europe and you're just across a boarder etc.)

Since that isn't what you asked... ... ...

You basically sum it up at the bottom. 621 difference at a cost of pouring your 50,000 into the property. If that is worth it, then you have your answer, if not, then you have your answer.

I punched the numbers into the mortgage calculator... You seem pretty much right on. One thing that did stick out, was the 50k extra payment lowered your overall interest paid by over 110k. Plus 10 years sooner payoff date. Assuming you don't make any additional lump payments/extra principal reduction. I also don't know how many years you have paid etc. Those numbers assume a 30yr @ 1387 a month.

But many people don't invest in Property for cashflow...my investment is a case in point (down $2k in cash flow for FY15, but up $70k in capital growth).

In many cases it's desirable not to pay off the mortgage and only pay interest only so you can free up cash to buy more properties.


island_guy

  • 5 O'Clock Shadow
  • *
  • Posts: 17
Re: Can someone with better maths than me check my calculations please?
« Reply #4 on: April 02, 2015, 02:18:31 AM »
Investing in a savings account is not really investing though....

My first thought is... The cash flow is pretty bad. In fact, it is almost certainly negative after taxes, insurance, and maintenance.

That said, I would suggest selling the property. Even if you did still live in the country, but, doubly so since you do not. (Unless you are not physically far away, ie Europe and you're just across a boarder etc.)

Since that isn't what you asked... ... ...

You basically sum it up at the bottom. 621 difference at a cost of pouring your 50,000 into the property. If that is worth it, then you have your answer, if not, then you have your answer.

I punched the numbers into the mortgage calculator... You seem pretty much right on. One thing that did stick out, was the 50k extra payment lowered your overall interest paid by over 110k. Plus 10 years sooner payoff date. Assuming you don't make any additional lump payments/extra principal reduction. I also don't know how many years you have paid etc. Those numbers assume a 30yr @ 1387 a month.

But many people don't invest in Property for cashflow...my investment is a case in point (down $2k in cash flow for FY15, but up $70k in capital growth).

In many cases it's desirable not to pay off the mortgage and only pay interest only so you can free up cash to buy more properties.

Thank you both for your responses.

To expand, part of my rationale for keeping the property was as follows:

1)  Rent almost exactly equals the mortgage payment (1,247.77/month) so we're neutral on that.

2)  therfore, only 170 cost per month (insurance + paying a mate to manage it) vs. 500ish in capital paid off each month.

3)  in the long term rent will increase with inflation but the mortgage payment will remain fixed (i.e. much smaller in 20 years time inflation adjusted money).

4)  also in the long term the amount of capital in each mortgage payment will increase (currently only 500 as a reasonably new mortgage but will increase to nearly all capital towards end of mortgage.

5)  in a reasonably desirable place so hopefully able to benefit from long term capital appreciation with little risk of depreciation.

I guess I saw myself 20 years down the line charging 4,000/month in rent with my same 1,250 mortgage payment being nearly all capital.

I think on this basis I'm going to keep the property and also not pay down the mortgage, freeing up the money to hopefully earn more than 3% - it looks like it only needs to increase to about 4% for me to be ahead money wise (due to the interest deduction against income tax).

Unless again, I'm missing something anybody can see?

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 28464
  • Age: -999
  • Location: Seattle, WA
Re: Can someone with better maths than me check my calculations please?
« Reply #5 on: April 02, 2015, 04:58:54 AM »
Investing only makes sense when you can do it at a rate higher than your mortgage. All is predicated on that. Otherwise you just have negative leverage.
I am a former teacher who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and am now settled with three kids.
If you want to know more about me, this Business Insider profile tells the story pretty well.
I (rarely) blog at AdventuringAlong.com. Check out the Now page to see what I'm up to currently.