Being a parent working towards owning your home carries with it many dilemmas, such as whether to save for child education now or pay more into your mortgage. So, how best to do both?
While the best option will depend on your family’s specific circumstances, two important strategies to consider are:
1. Directing spare cash into the mortgage and using draw-downs to fund education costs.
Benefits of this strategy:
- Reduce the total amount of interest paid on the mortgage.
- Receive an after-tax investment return equal to your mortgage interest rate.
- Invest amounts that are income and capital gains tax free.
- Have easy access to your cash if required sooner than anticipated with the flexibility of a re-draw facility available with some home loan products.
2. Investing in a managed fund dedicated to funding educational costs.
Problems with this strategy:
- Reduces the level of funding available to meet educational costs as income and capital gains tax are payable on managed fund investments.
- Investments made within a managed fund are subject to market fluctuations. When investment markets perform poorly, returns on the fund may be low or even negative. While investment returns are not guaranteed in lean years, it is possible to receive double-digit returns during the good years as an offset.
Other important factors to consider:
Investment timeframe before children start school
Managed funds are a long-term investment (seven years plus). If you only have a short-to-medium timeframe, investing in a managed fund is not usually recommended due to the risk that you may receive less upon withdrawal than was originally invested.
Time before retirement
Not many people would like to be paying a mortgage with their retirement income. Generally speaking, the further you are from retirement the more sense it makes to use the mortgage to fund education costs. Many people want the comfort and security of owning their own home, especially as they near retirement and are prepared to trade off any potential financial benefit accordingly.
How much interest are you paying on your mortgage? If your rate is higher than the managed fund return, it usually makes more sense to focus on paying down your mortgage, and to invest separately in a managed fund.
If you decide to use a managed fund, it is best to invest in the name of the parent on the lowest tax rate. Investing in the name of a child under 18 is generally undesirable due to the penalty tax rates that exist for income earned by minors.
If you’re not sure what would work best for your family, talk to your adviser.