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You won't find too many people that tell you paying off your mortgage is a bad idea. And whilst that might be right, I'm here to give you an example of what's potentially a far superior use of those extra repayments. In this episode, I'm going to walk you through an example of someone who wants to pay off their home loan in 10 years versus someone who puts the extra repayment to building a portfolio instead. The answer at the end might surprise you. I'm Junge Ma, lead research analyst at InvestorKit.
Let's get into it. If you're listening to this on iTunes or Spotify, definitely head to our YouTube channel. There's going to be a ton of charts on the screen that's going to make it even easier to understand. We've built two models for two scenarios. Person A buys a $1.
5 million home, putting $300,000 in their offset account and try their best to pay off their mortgage in 10 years. While person B also buys a $1. 5 million home, but they are not in a rush to pay off the mortgage. They'll just pay it off in 30 years. And instead of putting the $300,000 in their offset account, they use that amount as deposit to buy three properties in the three years following the year they bought their home.
To better understand how the models are working, I'm listing all the key assumptions here for you. For the home, or we can call it the PPOR, the annual value growth will be 6. 5%. The loan LVR would be 80%, so it'll be $1. 2 million loan.
The interest rate on average would be 4. 5% per year. And naturally, if we're trying to pay it off in 10 years, it definitely will be a principal and interest rate payment. And now for scenario two, the investment properties, the annual value growth will also be 6. 5%.
The loan LVR will be 90% instead of 80% for the home. Loan interest rate will be 6% higher than on the occupying homes. And repayment type, to reduce our financial pressure, we chose to use interest only repayment. The initial growth yield for these homes will be 4. 5%, just a moderate one.
We're not going for any really high yield areas. And the rental growth will be 4% each year on average. Then our annual holding cost, including our console fees and water rates, insurance, and so on, will be $5,000 each year. To pay off the $1. 2 million loan in just 10 years, person A will be paying the bank $151,000 per year.
And at the end of year 10, they will have the debt cleared with a 6. 5% annual growth. The home value will be $2. 6 million, and that is their debt-free asset. But at the same time, over the last 10 years, the total negative cash flow would be around $1.
6 million. So in the end, person A's net equity gain would be around $1 million. So $1 million net equity gain in just 10 years, that sounds really good, right? But stay with me. Let's check scenario two.
In scenario two, for your PPOR, you are just paying $73,000 per year to the bank because of the 30-year loan term. And by the end of year 10, your debt-free asset will be just $1. 7 million. But for this property, your total negative cash flow would be just around $825,000. Putting them together, your net equity gain from your home would be $860,000.
And now, one year after you have bought your main home, you purchased your first investment, which is valued at $700,000. In year 10, that value would become $1. 1 million. So your debt-free asset would be $528,000. And over the nine years you're holding it, your total negative cash flow would be around $60,000, giving you a net equity gain of around $469,000.
One year after investment number one, they purchased investment property number two, still $700,000 with $630,000 debt. At the end of year 10, debt-free assets would become $458,000, while total negative cash flow over the eight years of holding this one would be around $58,000, giving you a net equity gain of around $399,000. And then there is investment property number three, bought in the year after number two, still $700,000 with $630,000 loan. At the end of year 10, we'll get a $391,000 debt-free asset with around $56,000 total negative cash flow, giving you a net equity gain of $335,000. So adding all these net equity gains together, we are getting a total net equity gain of around $2 million.
If you remember in scenario one, person A just got around $1 million net equity gain. So that is doubling your capital growth. Now you might be asking, what about tax? I have to pay capital gains tax on all my investment properties if I sell them. Now let's compare that.
Assuming that we are selling all the properties in both scenario one and scenario two. In scenario one, because it's a major home, we're not paying any tax. So our net gain would still be $1 million. But in scenario two, we are paying capital gains tax on all three of the investment properties. And the total capital gains tax would be $254,000.
So our after tax gain would be $1. 8 million. That is still $800,000 higher than what we got in scenario number one. So there's some key takeaways. I really want to make sure you've got from this.
Number one, both investors were living in the same property. Number two, they both had the access to $300,000. And number three, in both scenarios, our investors were experiencing pretty negative cash flow. But scenario one, it was actually worse. One of them did have to pay a lot of tax.
But even after that big tax bill, they still came out over $800,000 ahead. And something else I want to leave you with. These scenarios are just over 10 years. Imagine in scenario two, they had bought another one or two properties. And we look at it over 20 to 30 years.
The difference is going to be staggering. So if you've been thinking, should I be putting extra money into paying off my mortgage faster? Or should I be putting it into a investment property or properties? While this is such a personal answer, I hope these scenarios I've shown you today help guide you to the answer that's going to be right for you the long term. My name is Junge Ma, lead research analyst at InvestorKit.
I'll see you next time.
