The Finance

Expatriate tax and finances

Using Debt To Make Money?

Most people assume they’ll be better off by paying off their mortgage as fast as possible. It just feels right, doesn't it?

However, financially it's the wrong decision for onshore clients and an even worse decision for international workers who can take advantage of tax efficient investment. Here are the reasons why: -

Gearing can be good when it boosts profits

If you buy a house worth £200,000 with a £100,000 mortgage and house prices rise by 10%, you have not just made a 10% profit. You only put up £100,000 of your own money, and on that you have made a 20% profit.

Trading up can increase your capital

So ’gearing’ - the use of borrowing to generate higher returns - has worked in spades in the home ownership market. The people who it has worked best for are those who have steadily increased their level of borrowings to finance the purchase of costlier houses.

If you owned a house worth £100,000 five years ago outright, it would now be worth maybe £200,000. But if at that time you had moved to one worth £200,000 with a £100,000 mortgage, it would now be worth £400,000 and instead of having capital of £200,000 you would have £300,000.

 Being swayed by emotion

So gearing is good for accumulating wealth. Why, then, are people so keen to pay off their mortgages? We believe there are several reasons:

• The belief that if you owe money on something, it’s not really ’yours’.
• Mortgage interest costs you now, increases in capital arise only later.
• By paying capital off the mortgage the total amount of interest you save is enormous.
• It seems easier to make extra mortgage repayments than to save into savings plans.

But ask yourself this: would you invest your money for 25 years for a 5% return? I hope not, because history tells us we should earn an average return of 5% a year on top of inflation whatever the inflation rate happens to be. Yet at current interest rates, if you pay capital off your mortgage, you are earning an annual return equal to the rate you pay on your loan, which should be around 5%.

Even when it’s bad, it’s good

On a long-term basis, an individual can always earn more than the rate they are paying on a mortgage. Of course there have been periods when that wasn’t true, but during those periods savings have bought more cheap shares that eventually made much bigger profits (a process called cost averaging).

So the combination of an interest-only mortgage and a stock market savings plan has strong arguments in its favour.

Since 1900, shares have produced higher returns than cash in about three-quarters of all five-year periods, in 90% of all 10-year periods and in 99% of all 18-year periods, according to the 2006 edition of the authoritative Barclays Equity-Gilt Study. So the odds are stacked in favour of coming out ahead by using an interest-only mortgage and a regular savings plan.

How big a surplus you end up with will depend on how good the investment managers of the funds you hold inside your savings plan are. Your financial adviser will be able to explain and help choose these funds and the right product to suit your circumstances. If you are an international worker you can access plans which are free of income and capital gains tax – as such there is even more reason to use this opportunity to get your finances in order.

What’s at stake?

Back in the 1980s, people who had used endowment mortgages ended up with surpluses of 30% of the amount they owed on their mortgages. It could happen again. Assume you earn a greater return on your savings plan than your loan. Then on a £100,000 mortgage over 25 years, the strategy would deliver a surplus of:

• if you earned 3% a year extra, £61,000
• if you earned 5% a year extra, £124,000

Even more reasons to stay in debt

Here are some more reasons why I won’t be paying off my loan.

• Pay money off your mortgage and then, if you need cash, you have to go and ask for it and if your circumstances have changed, the lender may say ’No’. Build up money in your own savings plan and nobody can tell you what you can or can’t do with it.
• ’Offsetting’ is a great way to maximise the return on your ’instant access’ money without actually having to kiss it goodbye. Why pay money off the loan when you can keep your money and get the benefit of lower interest payments?
• By the time the mortgage maturity date arrives, I hope I will have a capital sum larger than the loan and that I will be able to generate annual income from it sufficient to pay the interest. If I can do that, and the mortgage is earning me a profit, why would I ever want to repay it?
• In my old age, I expect my estate will be subject to inheritance tax. So avoiding it will become an issue. Having a loan on my home and using trusts to pass the same amount of cash onto my heirs will save me (or rather them) a bundle in tax.

All future correspondance with be handled directly by the author. We will have no involvement in your financial matters or queries.