Advice Market Blog
I’m making good money at present – should I pay off my mortgage quicker or invest the money elsewhere?
July 20, 2016
It’s a nice problem to have. Surplus cash is a great situation to be in for anyone looking to grow their wealth and plan for their future. With it however comes the dilemma of how to make that extra money work as effectively as possible for you.
Every investment decision comes with an opportunity cost. By choosing one option you, by definition, rule out all others, and with investing being an uncertain science it is always difficult to know what option is best.
Choosing between paying off your mortgage or investing the money can be a challenging decision to deal with. The obvious answer is to spread your choices and look to do a little of both. It helps however if you can approach the problem both from a quantitative (numerical) and a qualitative (emotional) perspective.
Let’s talk numbers first. Your interest rate will be the most important factor dictating your decision when it comes to comparing the return from an investment with your mortgage – but raw numbers are not enough. You may, for example, be paying 5% interest on your mortgage and this would indicate that an investment offering a higher return than 5% would make more sense. Raw numbers are only part of the story however. Firstly what about tax? If your mortgage is on your home then it is unlikely to be tax deductible. The income from your investment however probably is – and if you are earning good money you might be on a relatively high rate of tax on that income.
Assuming you are on the highest marginal tax rate of 37% you would need to earn a return of 7.93% (7.93% – (7.93* x 0.37)) in order to net a return of 5% after tax, the equivalent of paying off your mortgage. In order to be a better option you would want to be earning in excess of this so an 8% – 10% is more likely to be the area you are aiming for.
So what are the emotional factors to consider? Aside from the return there are other things that will help dictate your decision. The first is risk. Is an investment yielding 7.93% of equal value to paying off your mortgage at 5%? In simple terms no. Your mortgage has a degree of certainty to it. If your interest rate is fixed there is a very little that will affect the 5% saving you will yield if paying more off your mortgage. Your investment however lacks this certainty. Any investment in the current market yielding close to 8% will carry a degree of risk in terms of, firstly, achieving the required rate of return, and secondly, receiving your investment amount back at all.
The second is timing. If your mortgage payments are fortnightly then you will be receiving the benefits of your mortgage repayment fortnight through the reduced amount you will be paying, your investment however might not pay so frequently depending on what it is. Interest on bonds might be received every three to six months. Dividends can be six monthly, property returns or share market profits may not accrue until the asset is sold.
The third is flexibility. Depending on the type of investment you are considering there will generally be the opportunity to sell the investment up should you need the money back. If you choose to pay off a standard mortgage however the bank will normally not allow you to redraw it unless you have a facility in place that will allow this, such as a revolving credit or drawdown loan. This would make an investment a better option if you see yourself needing to reuse the funds again in the foreseeable future.
The choices are many and varied when it comes to making a decision. A combination of investment and mortgage repayment might be the best answer but it’s important to discuss all of your options with a qualified mortgage broker or investment planner. How you are structured, when you will need the money, and what you are seeking to achieve will all dictate the option that is right for you. It’s not a decision to be made lightly or on your own.
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The information provided is intended as a guide only and does not take into consideration your personal situation, needs and objectives and should not be considered as advice of any nature.