Pay off the mortgage faster, or invest?

Should I pay off the mortgage faster, or use that extra cash to invest?

This is always a common question, and it’s especially relevant today.

While mortgage rates are way down from the highs of 2023, borrowing costs are still above the average of the past 15 years.

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Right off the bat, let me point out that this question is only relevant if you’re a disciplined saver.

Because if you’re not, and you’re inclined to spend any spare money rather than investing it, you should pay your debt off as quickly as possible.

For those with a tendency to give in to temptation, paying off the mortgage can work like a forced savings scheme, and that’s exactly what you might need.

For others, it’s difficult to give a definitive answer as it’s not completely black and white.

Paying down the mortgage as quickly as you can is sensible, and it’ll help set you on the path to financial freedom.

It’ll also allow you to borrow it back again later.

If you do that to invest in income generating assets (be it an investment property, a business or a share portfolio) your interest is a tax-deductible expense (unlike the original mortgage on your family home).

That can be a very tax-effective way of structuring your borrowings.

However, using some of your spare money to invest along the way can also be wise.

The best one-year fixed mortgage rate is just below five per cent right now, so if you make additional payments on your mortgage, that’s essentially the annual return you’re getting on that money.

Your other options for putting those funds to work will give you a varying range of returns.

Term deposits are a very low risk option, and the one-year advertised rate is sitting at 3.8 per cent right now (before tax, that is).

Apart from your liquidity buffer or emergency fund, there’s no point leaving excess money on deposit at 3.8 per cent if you’ve got a mortgage costing you five.

You’ve got to service that out of your after-tax income, as well.

Managed funds, shares and property all offer much better returns than term deposits, albeit with a higher risk profile and more volatility.

Shares have delivered annual returns of 8-10 per cent over the past 30 years, while house prices have risen about six per cent per annum over that period.

Those gains are above the current cost of borrowing, and higher than where mortgage rates have been for the bulk of the past decade.

However, just like any growth asset the gains don’t come consistently.

The sharemarket has had numerous ups and downs along the way, including four bigger declines of more than 25 per cent.

House prices have been in an extended slump and are still more than 15 per cent below 2021 levels.

In time markets recover, and in hindsight we often look back on the difficult periods fondly because of the opportunities we were able to take advantage of.

However, the rough patches can be highly disconcerting when we’re in the thick of them.

In contrast, the “return” one gets from paying down the mortgage is free of risk, volatility and uncertainty.

If your one-year fixed rate is five per cent, the return (which is the interest you’ll save) isn’t at the mercy of economic conditions, politicians and policymakers, or market sentiment.

It’s 100 per cent rock solid and guaranteed.

That’s why the textbook, Excel spreadsheet, and your purist accountant friend might all suggest paying down the mortgage.

Because there’s nowhere in the investment world where you’ll find a similar return for zero risk.

But it’s never that simple, is it, and that’s not always the right approach for everyone.

Doing a bit of investing on the side can be a very good choice for many people.

Maybe you’ll catch a wave of great returns and make much more than you would’ve saved in interest.

Even if you don’t, the knowledge gained by educating yourself about money and markets could prove invaluable.

When people have skin in the game, they tend to pay much more attention to something.

Having a few investment interests – even modest ones – might give you the motivation to follow the economy more closely, read the business pages more often, and learn how financial markets work.

While you’re unlikely to find a better risk and return proposition than making additional mortgage payments, you’ll learn a lot and put yourself in good stead to make better decisions in the future.

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