Use home equity to buy rental or pay off 90K mortgage first?

[Foxy66]

OK, so I'm new to this site but am loving it. We are a 2 income family in NZ ( so some mortgage rules are different - interest rates are currently 5.75%), making 60K in the hand. We have no debts other than our mortgage. We have been living under ours means, but I realise we can do a lot better. My goal is to save 40% of our money - we are currently saving about 30%.

We own our home with a mortgage of 90K, and it's worth about 230K. I am on contract based work and have 2 years left on my contract. Because it's based on a funding model, I don't have any control over it - even if I work amazingly, if we don't get the funding from the government, I don't have a job, and this is a source of concern for me, however I like my work and it's always been fine so far. I work part time (9-3) which I would like to keep doing as this is great with the kids in school and not having to pay after school care.

My query is wether we should pay off the mortgage first, or borrow equity to invest in a rental. We had a major issue earlier in the year - we purchased a bigger house, and my husband had a car accident and I freaked out over having two mortgages to pay and panicked about what would happen if we couldn't get renters etc - so we sold the new house immediately and lost money - but I could sleep again.

So I'm obviously very risk and debt adverse.

However, I do see property as a great tool and investment and I think we should pursue it. My other concern is that house prices will rise here and then it will be harder for us to purchase a rental and we could be missing out on opportunities just because I'm scared to act now. The other thing is I feel we've really outgrown our house ( and I know that's very anti mustaschian but it is a tiny house and part of me is wanting to buy a slightly bigger (but cheap) house and rent out our current home).

So I'm not sure what to do.

The safest way in my mind is to pay off our mortgage ( we're on revolving credit and could realistically pay it off in 2-3 years), then purchase either a rental or a slightly bigger house for ourselves.
CONS - house prices could rise making it harder to purchase another place, means we have to make do in our current house a bit longer.

OR

Buy a rental ( or rent ours out), buy a realistically priced house for us now, and pay that mortgage off quickly ( so say total mortgage of 300K which even if we didn't have any rental income we could cover with our wages). The mortgage for the rental will be Interest only until we pay off our 'home' mortgage, then we could reduce the debt on the rental

Cons - more debt, more potential for trouble if we lose jobs, rent etc. Less of a safety net.
PROS - would have a rental now and beat any house rises. Would have a roomier place for us to live (note our current house is 90M2, so I'm not talking a mansion here).


Having written this out, it now seems to me we should just pay off our mortgage first. But I'm worried we could be missing out on investment opportunities and make our money work for us using the home equity.

Would really appreciate any views on this, thanks.

[Numbers Man]

Everyone that responds will probably have a bias on the mortgage payoff question. It seems to me that you need to take some time to reflect on what your goal really is. If it is to buy another house in the near future, then what is the point of paying off the current mortgage? You need to decide if you have the appetite to be a Landlord, it seems like you don't.

[Foxy66]

Yes, that's true why pay off our mortgage is we're going to borrow against it again to buy another place? I guess I feel the risk will be lower, as the total mortgage will be lower, and if something happens to my job, then at least we'll have a house paid off. And I think it would be satisfying to have accomplished paying it off.

But in the meantime it would be nice to have a bigger house......

I would like to have a rental to provide income, but I don't ever see myself being comfortable with several houses all with mortgages.

I guess I'm just wondering what makes sense financially, and hoping that will help me decide.

[CopperTex]

I would pay off the mortgage first.  If you had a paid off house, would you take a loan out against it to purchase rental property? Ask yourself that question and the answer will reveal itself.

[Another Reader]

Well, in 2009 I refinanced my primary residence at a lower rate and I maxed out the loan.  Over the next two years, I bought four rentals for cash at the bottom of the market with the equity I pulled out and some other cash.  Those rentals have almost doubled in value since I bought them.  I refinanced again at close to the bottom last December, and the net income from those four houses alone pays all of the mortgage on my primary house and a good bit more.  So yes, I would take a loan out against my house to buy rental property if the numbers supported doing that.

Debt is a tool.  Used wisely, debt (leverage) can accelerate wealth building.  I would not pay off a 3.75 percent mortgage if I were confident that I could invest the money and make a higher rate of return over the life of the loan.  I might not borrow more today because the investment opportunities are not as good as they were, but I would be in no hurry to pay that loan off.

[mustacheme]

I think you could receive good advice that would say buy the rental. I think you could also receive equally good advice that would say pay off your house. The reason is that while leveraging into a rental might be the financially logic "best" advice, paying off the debt might be the emotionally "best" advice.

Since you mentioned losing sleep earlier this year when you owned two homes, I think you might earn yourself significant mental returns by paying off your house first. Only you can really make this decision. Either way, it sounds  like you're in a good position with two good options.