Investing, Life

Should you pay off your mortgage or invest?

The recent fall in interest rates has reignited the debate. Should you invest or pay down your mortgage?

The appeal of owning your home outright is top of the financial priority list for most people. Indeed, it’s usually better for homeowners to pay down a mortgage until they are comfortable with covering monthly repayments and have a significant buffer in their offset account.

However, with mortgage interest rates now around 3% and likely to go down further, mortgage repayments are becoming less of a financial burden on homeowners who have already paid down a large chunk of their mortgage.

The simple math

A good example is if you have a mortgage of $100,000 and are paying $3,000 per year in interest (3%), you would need to find an investment that earns a higher return than 3% per year to be better off investing than paying down the mortgage (or adding to the offset account).

Should I buy a term deposit?

The short answer is no. It may seem like the safe option to put the extra money you have into savings or a term deposit, but you’d be worse off compared to paying down your mortgage (or adding to your mortgage offset account).

Term deposits currently pay around 1.5%, this is less than a typical mortgage rate of 3% so you’d be locking in a loss of 1.5% per year. Plus the interest earned on a term deposit will be taxable income, whereas there is no tax deduction for interest on owner occupied home loans.

What investments should I consider?

If you want to invest instead of paying down your mortgage (or adding to the offset account), it only makes sense to consider investments which can achieve at least the same return as your mortgage interest rate.

Investments like Australian shares, international shares and high grade bonds have all exceeded the average mortgage interest rate over the long run. Compare their returns below against the your current mortgage interest rate (on average between 2.8% and 3.8% p.a.).

1 year (2018/9)5 years (p.a.)10 years (p.a.)
Australian shares11.0%9.0%10.0%
International shares11.9%13.2%12.4%
High grade bonds9.6%5.1%6.0%

Source: RBA, Vanguard, LMBA, S&P/ASX All Ordinaries Accumulation Index, MSCI World ex-Australia Net Total Return Index, Bloomberg Composite Bond Accumulation Index

Note: that the after tax return on these investments will vary based on the level of franking credits and concessional capital gains as well as your tax position.

Investing is a long-term play

You should only consider investing if you can do it for the long-term. The day-to-day share market movements become much less relevant over time, so the decision to invest should be based on a long-term horizon.

As we always say at Stockspot, the longer you invest, the better your chance of success. Also, because some of these asset classes do well at the same time that others do poorly it is a safer strategy to invest in a balanced portfolio with a mix of different assets.

A diversified investment portfolio with Stockspot has earned 7-10% over the long run and is much less risk than just owning Australian shares.

Stockspot portfolio returns*5 years (p.a.)Total 5 year returns
Amethyst (conservative)7.5%51.9%
Sapphire (moderately conservative)8.2%56.8%
Turquoise (balanced)8.5%58.5%
Emerald (growth)9.1%63.1%
Topaz (high growth)10.0%72.7%

*Returns are after-fees as at 30 September 2019. Past performance of financial products is no guarantee of future performance.

We believe low-cost ETFs are best and safest way to diversify your money across investments. It’s also important to keep your costs low when you invest as everything you pay in fees nibbles into your returns. This is particularly pertinent if you also have a mortgage.

Should I buy an investment property?

Q: What’s better than one property?
A: Two properties!

In Australia it’s almost seen as a right of passage into true adulthood to own a rental property. You might consider using your ‘excess’ savings to invest in another property.

The tax advantages of negative gearing can be attractive. It’s been a popular strategy in Australia but it’s risky as it concentrates your assets into one investment class and increases your debt as you’re likely to take out another mortgage.

Negative gearing means that more of your cash is spent on interest and maintaining a property than the rent received. According to SQM Research gross yield (rent income) received for houses in Australia is 3.2% and for units 4%.

Even in a low interest rate environment it is easy to see how maintenance costs can exceed rental returns. There are other factors to think about such as your lifestyle, your risk tolerance and of course your marginal tax rate.

The appeal of owning your home outright asap may be more important to you than earning a better return by investing.

Factors to consider

If you’re lucky and your mortgage repayments are no longer a difficult financial burden, and you have spare savings available, there are options available to you.

Rather than paying off the mortgage as quickly as possible, it may be a smart strategy to diversify your wealth across different investments.

Both paying down your mortgage and investing will result in increasing your savings so both are going to be positive for your overall wealth.

The main difference is that paying down your mortgage will reduce your debt (borrowing) whereas investing will diversify your overall wealth and income.

There are other factors to think about such as your lifestyle, your risk capacity and of course your marginal tax rate. The appeal of owning your home outright as soon as possible may be more important to you than earning a better return by investing so it’s really a personal decision.

Invest or pay down your mortgage checklist

Here’s some of the key factors to consider:

FactorPay down mortgage / add to offset accountInvest extra savings
ReturnsIt makes more sense to consider investing when mortgage interest rates are lower. Currently owner-occupied mortgage rates are around 3% p.a.You need to compare the expected return from investments to the mortgage interest rate. Over the long run a diversified Stockspot portfolio has earned 7-10% p.a.
TaxIs your interest tax deductible? This is based on whether it’s your primary residence or an investment property.The after tax return from investments will vary based on the level of franking credits and concessional capital gains as well as your tax position.
Time horizonIt’s a safer option to pay down the mortgage if the period remaining on it is less than 3 years.The longer you have to pay your mortgage, the more attractive investing becomes. You have a better chance of earning more than the mortgage interest rate from your investments.
Safety bufferYou need to build significant safety buffer and be ahead on mortgage repayments before considering investing.Make sure investments can be easily sold should your circumstances suddenly require you to pay down more of the mortgage.
Income certaintyIf your work income is less certain it makes more sense to pay down your mortgage.If your work income is stable, investing is more attractive. There’s less risk you’ll need to sell down your portfolio early to meet mortgage repayments.

This article was originally published in October 2019.

Stockspot is Australia’s largest online investment adviser. We build you a smart, personalised investment portfolio using proven strategies to grow your wealth as an alternative to investing in property.

Founder and CEO

Chris has been vocal in calling out the industry 'Fat Cats' and is known for telling it as it is. He sits on two Advisory Committees for the industry regulator ASIC, and was previously a fund manager at UBS. He holds a Bachelor of Commerce (Accounting/Finance Co-op Scholarship) from UNSW.

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