Pay off your mortgage early or invest?
Posted by Northadvisory on July 29, 2020
It’s a question that keeps many Australian homeowners up at night. If you have a little extra savings up your sleeve – should you pay down your mortgage early or invest?
There’s little doubt that for many homeowners, reducing the burden of debt from a mortgage is incredibly tempting. And it seems like a quick way to financial security.
Plus with historically low interest rates it can feel like the obvious choice… but it might not be the most strategic one in the long run.
Before you go making additional payments into your home loan… it could pay to weigh up your options by doing some simple number crunching. And taking your personal considerations into account – you’ll feel more confident in your wealth building strategy – no matter what decision you make.
What matters most?
Before you dive deep into the number crunching and weighing up pros and cons, you should first ask yourself: which goal is more important?
Is it to be mortgage free? Repaying your home loan and owning your property outright can give you peace of mind in knowing that you will have a roof over your head. Eliminating the financial obligations of mortgage repayments can help improve your quality of life and your financial well-being.
Or are you looking to build your wealth and secure your financial future by diversifying your investments? Concentrating your wealth into one asset can be a risky strategy, especially if it’s tied up in the residential property market. Your wealth could become vulnerable in the event of a downturn in the market. Investing the additional funds could make a significant difference in your overall financial position… for the long term.
It pays to crunch the numbers
Regardless of your long-term financial goal, it is always worth taking a few minutes to run the numbers. It can help paint a picture of where each path can take you and your family.
Let’s assume that you have an extra $500 a month to play with. For this example we will use a 30 year, $500,000 mortgage at a 3.0% interest rate.
It’s important to keep in mind that current rates are actually lower, but we have used it for illustrative purposes. And as rates decrease or increase over the 30 year period, these figures would change.
The Government’s Moneysmart online mortgage calculator indicates that the monthly repayments on this mortgage would be $2,108 per month.
Monthly fees have not been included in this scenario as these can vary depending on the lender. After 30 years your mortgage would be finalised and you would have paid $258,887 in interest over that time.
With an additional $500 a month paid into the home loan, you would reduce the interest paid to only $185,320 and the term of the loan to 21 years and 11 months. That’s more than eight years sooner and $100,576 less interest.
But what if you were to invest that $500 a month instead? With an average investment return of 7.5% and the beauty of compounding interest, your money will work harder for you. And you’ll see a significant increase in your investment over the three decades.
The Government’s Moneysmart compound interest calculator indicates that your investment would be worth $673,723 at the same time that your mortgage would be finalised.
That leaves a dramatic $573,156 difference between the amount of interest you saved on your mortgage and the investment you have grown.
Think of it this way – as long as the average return of investment remains higher than your interest rate on your mortgage it could make more sense to grow your wealth using an investment strategy.
Anything else I should consider?
Whilst the calculations in the example give a positive story to investing… it’s important you look at your personal considerations so you can make the best decision for you and your family.
It’s clear that when it comes to finances, some people are more comfortable with taking risks than others. Knowing which side of the coin you are on will help you make a confident decision. And remember either way reducing your mortgage or investing will increase your assets.
The next thing to consider is your lifestyle factors. If you are in your thirties then you might make a different choice to someone closer to retirement.
And don’t forget that your marginal tax rate could influence your decision. For those on a higher income bracket you might find your investment income is taxed at a higher rate. In this case paying off your mortgage might be the better way to go. A financial adviser can help you analyse your options and decide what’s best for you.
Be better off
A financial adviser can help you assess whether you should refinance to get a better rate for your home loan. Taking a few minutes out of your day to sit down and review your current home loan could save you in the long run.
Seeking professional services can help you determine whether paying off your mortgage or investing is best suited to your homeownership goals, lifestyle and risk tolerance.