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?

Mortgage interest rates are now around 3% and likely to go down further, so if you’re living the Australian dream and own your own property, your mortgage repayments could be less of a financial burden now than they once were. 

If that’s the case, perhaps you’re thinking of how to reframe your finances so you’re even better set up for the future. Should you pay your mortgage down even further and be free from the shackles of your lender or bank? Or should you invest in other assets and potentially get returns that provide a comfortable financial cushion? 

What to consider when you’re paying down a mortgage

If you’re lucky and current low interest rates mean your mortgage repayments are no longer as much of a financial burden, then you might have extra money. 

Rather than paying off the mortgage as quickly as possible, you might want to diversify your wealth across different investments.

Paying down your mortgage and investing will both result in increasing your savings, but 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. This video covers some of the key considerations.

I want to invest. How much should my investments earn?

If you’re leaning towards investing, you want to make sure it’s worth it.

Let’s start with an example of a $100,000 mortgage. If interest rates are 3%, then you’d pay $3,000 per year in interest.

This means you’d need to find an investment that earns a higher return than 3% per year to be better off investing than paying down your mortgage (or adding to an offset account).

Should I buy a term deposit instead of paying down my mortgage?

The short answer is no. It may seem like the safe option to put the extra money you have into a 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 less than 1%, and 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.

If you want to invest instead of paying down your mortgage (or adding to the offset account), you need 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 year5 years (p.a.)10 years (p.a.)
Australian shares3.6%9.3%7.9%
International shares6.3%11.6%13.9%
High grade bonds4.5%4.6%5.6%
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: after tax, the return on these investments will vary based on the level of franking credits and concessional capital gains as well as your tax position.

Should I invest in shares instead of paying down my mortgage?

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 strategy.

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’s a safer strategy to invest in a balanced portfolio with a mix of different assets.

A Stockspot diversified investment portfolio of low-cost ETFs has earned 7-10% over the long run and is much less risky than just owning Australian shares.

Stockspot portfolio returns*5 years (p.a.)Total 5 year returns
Amethyst (conservative)8.0%46.9%
Sapphire (moderately conservative)8.5%50.4%
Turquoise (balanced)8.9%53.2%
Emerald (growth)9.6%58.1%
Topaz (high growth)10.4%64.0%

*Returns are after-fees as at 31 December 2020. Past performance of financial products is no guarantee of future performance.

It’s also important to keep your costs low when you invest as everything you pay in fees eats into your returns. This is particularly pertinent if you also have a mortgage.

Pay off your mortgage or invest? Here’s a checklist

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 a significant safety buffer and be ahead on mortgage repayments before considering investing.Make sure your investments can be easily sold should your circumstances suddenly require you to pay down more of the mortgage.
Income certaintyIf your 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 and updated in February 2021 with current information.

Whether you’re planning to invest in property, save for a house deposit, or you just want an alternative way to grow your wealth – we can help.

Founder and CEO

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

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