Paying off your mortgage is safer than investing elsewhere

Pay Off Mortgage or Invest? Pros & Cons and What To Choose

Deciding to pay mortgage off or invest somewhere else is a tricky choice to make since it depends entirely on your finances and goals.


Both options have their own set of advantages and disadvantages, which makes it important for you to be informed enough to make the best decision possible.


That’s why we’re discussing everything about paying off a mortgage or investing instead in this guide. We’ll explore the advantages, disadvantages, things to consider, and more to help you identify what the right choice is for you.


This guide is of a general nature and does not take into account your personal financial circumstances. Kindly seek personalised advice from a qualified legal professional or financial adviser to find the right solution for your needs.


Advantages of Paying off Your Mortgage


Most mortgage holders consider it safe to pay off mortgage early. Especially since you can save a good chunk of money when paid early versus paying through the entire tenure of the loan.


Here’s an example:


Imagine you have a mortgage of $300,000 with a 30-year term and an interest rate of 4%. If you stick to your regular monthly payments, you’d end up paying a total of about $514,000 over the life of the loan, which includes nearly $214,000 in interest alone. 


Now, let’s say you decide to make extra payments and pay it off in 15 years instead—your total interest paid drops significantly, and you could save almost $107,000 in interest payments.


By making just a small additional monthly payment towards the principal or paying down more with a lump sum, you can shave off a few years from your loan and cut down the interest you owe. 


This means not only less time shackled to debt but also greater financial freedom sooner.


Please note that any figures (including interest rates, mortgage amounts, and share market returns) provided throughout this guide are illustrative and subject to change. They may vary in the real world, depending on individual credit profiles, loan products, and current market conditions.


Return Equivalent to the Mortgage Interest Rate


When you pay off your mortgage early, you're essentially eliminating the interest payments that would have accrued over the remaining years of the loan. 


This means you're locking in a guaranteed return equal to your mortgage interest rate, which can often be higher than the returns you might get from other investments. 


Taking the example above, if your mortgage interest rate is 4%, paying off your loan early gives you a 4% return on your money, risk-free.


Unlike investing, where returns aren't certain, this is a safer way to “earn" that 4% by reducing what you owe.


Reduction in Overall Interest Paid


As seen in the example above, paying off your mortgage early means you pay less interest over the life of your loan. This translates to less money paid overall for your mortgage.


Increased Equity


Your equity in the home increases with every dollar you pay towards the principal of your mortgage.


Paying off your mortgage means you get to outright own the house you bought. If needed, you can also pledge this increased equity for more money to renovate or use for any other purposes.


Increased Cash Flow


Early full payment on your mortgage enhances your financial flexibility by providing you with additional cash flow each month. 


Without a mortgage payment, you'll have more disposable income that you can allocate towards savings, investments, or other financial goals. 


Psychological Benefits


With a fully settled mortgage, you get peace of mind, reduce financial stress, and effectively avoid falling into mortgage stress in case your finances get tight in the future. So, no more stressing about repayments, interests, or fully owning your home.


Disadvantages of Paying off Your Mortgage Early


While paying off mortgage benefits mortgage holders in many ways, it also has disadvantages that are worth looking into.


Potential Loss of Liquidity and Reduced Emergency Funds


Using a significant portion of your savings to pay off your mortgage early could leave you with limited cash reserves. 


This can make it challenging to cover unexpected expenses, especially medical emergencies, home repairs, or job loss, in case you don’t have separate emergency funds reserved for them. 


Missed Opportunities for Potentially Higher Investment Returns


If you allocate extra funds towards your mortgage, you might miss out on investment opportunities that could offer higher returns.


Historically, diversified investment portfolios, like stocks, bonds, and real estate, have delivered average annual returns that often exceed the potential savings from paying off a mortgage, especially compared to low-rate mortgages.


Early Repayment Fees or Penalties


Some mortgage agreements include early repayment fees or prepayment penalties, which can diminish the financial benefits of paying off your loan early. 


There may also be potential repayment limits that cap the extra amount of money you can repay in a given period.


Consider consulting your licensed lender or mortgage broker to be informed of any such fees, penalties, or limits before paying down your mortgage.


Advantages of Investing


Investing is a more aggressive approach to using your money compared to paying off your mortgage. You get plenty of financial opportunities here, including the potential for higher returns and diversification.


It’s a great option if you have long-term financial goals, but it does come with risks, which we’ll cover in the next section.


Let’s look at the benefits now...


Potential for Higher Returns


If an investment option like the stock market offers an average return of 8-12% annually, you could get twice the amount of money you would’ve saved by paying off the mortgage.


But keep in mind that this is only a hypothetical figure. Real investment returns in Australia may vary depending on current market conditions.


Diversification of Assets and Income Streams


Putting your money into investments outside your mortgage gives you the opportunity to diversify your assets and income streams.


You could purchase more real estate, start or buy a business, invest in diversified portfolios like stocks and bonds, etc. 


But again, investments carry more risk compared to the more promising savings you could get by paying off a mortgage. Kindly consult a legal professional or financial adviser before making any risky decisions.


Utilisation of Superannuation


Another great benefit of investing is that you can explore Australian investment options with tax advantages, like your super


It can be a great tax-effective investment strategy, especially for long-term goals like retirement. To fully benefit from it, consider salary sacrificing to your super to easily build up your funds, thereby reducing your taxable income as well.


Concessional (before tax) contributions to your superannuation are taxed at a maximum rate of 15%. Or at 30% if your concessional contributions combined with your income exceed $250,000.


Here’s an example of a 15% tax rate for super contributions…

  • Income: $200,000

  • Concessional Contributions: $25,000

  • Total: $225,000 (below $250,000 threshold)

  • Tax Rate: 15% on all $25,000 of concessional contributions.


Example of a 30% tax rate for super contributions…

  • Income: $230,000

  • Concessional Contributions: $25,000

  • Total: $255,000 (above $250,000 threshold)

  • Tax Rate:

    • In this case, $20,000 of your concessional contributions are taxed at 15%.

    • But the remaining $5,000 is taxed at 30% since it is beyond the threshold.


In case you’re yet to buy your first home to live in, you can utilise the First Home Super Saver (FHSS) scheme that allows you to make voluntary contributions to your super to build up the deposit fund for your first home.


Through this scheme, you can withdraw up to $15,000 from your voluntary super contributions in a financial year, up to a total of $50,000 across multiple years.


Kindly refer to the official ATO government website to know more about eligible contributions.


Disadvantages of Investing


Investing your money outside your mortgage is naturally risky. Mainly because the returns are never guaranteed. 


While there’s a huge potential for financial benefits here, you have to carefully consider the disadvantages to evaluate whether the risks are worth it depending on your financial situation.


Investment Risks


A major disadvantage is the risk associated with investments. Market volatility and potential capital loss are common when investing outside your mortgage.


This is why it’s vital to do your research and consult a financial adviser before making any investments. If you do not have a backup or your finances are very limited, a wrong investment could literally shatter you.


Ongoing Costs and Fees


Many investment vehicles come with management fees, transaction costs, and advisory fees that can eat into your returns over time. 


Even seemingly small fees can accumulate and reduce your overall investment growth, so make sure that you understand what you're paying for and seek cost-effective options whenever possible.


Tax Implications


Investing can also lead to complex tax implications that may catch investors off guard. 


Capital gains taxes on profits from investments can significantly reduce your returns, particularly if you sell assets within a short time frame. 


You need to understand these tax implications well to make sure your returns aren’t negatively affected. Consult a legal professional or financial adviser to learn more about your investment needs and associated taxes.


Emotional Stress


The ups and downs of the market may create anxiety and uncertainty, particularly if you are not well-versed in financial matters. 


Watching your investments fluctuate can be nerve-wracking, and it’s easy to let fear heavily influence your decisions. This could lead to impulsive actions that may further harm your finances.


Develop a strong mindset and a long-term perspective when investing. Keep in mind that market fluctuations are normal. Practice discipline and patience, and don’t let your emotions control your actions.


Factors to Consider When Making Your Decision

Consider your risk tolerance when deciding to pay off mortgage or invest


Before deciding to pay off your mortgage or invest that money somewhere else, you need to consider a few key factors to make sure you’re picking the right choice.


This is very important since the right decision for you depends on your unique goals and finances.


Interest Rate Comparison


Ideally, if you want to invest your money somewhere else, the expected returns should be twice or more than the interest rate on your mortgage.


For instance, it only makes sense to invest your money where returns are expected to be 8%+ while your mortgage interest is 4%. This way, you can gradually pay off the mortgage with half of the profits you yield from the investment and save the rest, which puts you in a safe financial environment.


In case your expected return is lower, it’s safer to just pay off your mortgage.


Risk Tolerance


The next factor to consider is your comfort level with investment risk versus the security of debt repayment.


If your finances are tight, you’re better off paying down your mortgage. That’s the safest bet you can take.


Consider investing elsewhere only if you have an abundance of money with sufficient savings for unexpected emergencies and expenses.


It’s always worth consulting a financial adviser to get a tailored solution for your situation.


Financial Goals


Align your decision with any short-term and long-term financial objectives.


Short-term goals may include establishing an emergency fund, saving for a vacation, or funding a child's education. If any of these apply to you, paying off your mortgage might be a more prudent choice, as it frees up cash flow and reduces your monthly obligations.


On the other hand, if your focus is on long-term growth, investing your excess funds could be more beneficial.


Consider how paying off your mortgage impacts your financial trajectory over the coming years. For example, building wealth through investments might offer greater long-term benefits, particularly if you start early and take advantage of compound interest.


However, that may not be the wise choice if your risk tolerance is low and the available investment opportunities aren’t promising viable returns.


Tax Considerations


Mortgage interest payments on investment properties in Australia are often tax-deductible, which can provide significant savings, especially in the early years of the loan when interest payments are at their highest. 


However, investments such as stocks or mutual funds have their own tax implications, including capital gains taxes when selling assets at a profit. 


It’s also worth noting that assets sold after being held for more than 12 months are eligible for a 50% discount on capital gains tax (CGT).


Evaluate how these taxes will impact your net returns compared to the savings from mortgage interest deductions. A discussion with a tax professional or financial adviser can provide clarity on how best to navigate these considerations in relation to your individual financial situation.


Liquidity Needs


Another key factor to evaluate is your liquidity needs. 


Maintaining accessible funds for immediate needs or emergencies is necessary. If you use all your savings to pay off your mortgage or invest elsewhere (liquid investments are an exception), you may find yourself cash-strapped in an unforeseen situation, such as a medical emergency or unexpected home repairs.


Having liquidity means you can quickly access cash without incurring penalties or selling investments at a loss. 


If you have minimal savings after paying off your mortgage, this could lead to financial strain, especially if your income fluctuates or unexpected expenses arise.


Pay Off Mortgage or Invest: Case Studies and Scenarios


We mentioned your decision to pay off mortgage or invest elsewhere solely depends on your unique finances and goals. To put that into perspective, we’ve made three unique scenarios that are most common across Australian mortgage holders.


Identify which of these mortgage-holder profiles you fall into. The most relevant category below will help you with the right financial decision to take. 


Scenario 1: High-Interest Mortgage With Low Risk Tolerance


Mortgage holder profile:

  • Mortgage Interest Rate: 6%

  • Risk Tolerance: Low

  • Financial Goals: Reduce debt, minimise financial anxiety


If you are a mortgage holder with a similar profile like this (with a high-interest mortgage), prioritising repayment often makes the most financial sense. Here’s why:

  • Savings: Paying off a mortgage with a 6% interest rate is equivalent to earning a 6% return on investment, risk-free. This is a solid "investment" compared to the unpredictable returns of the stock market.

  • Peace of mind: Mortgage holders with a low risk tolerance often prefer financial stability over the uncertainty of market fluctuations. Eliminating debt eases your mental stress and reduces monthly financial obligations.

  • Long-term savings: Paying off the mortgage significantly reduces the total interest paid over the life of the loan, which could potentially save you tens of thousands of dollars.


Consider taking this approach if:

  • You lack confidence in your ability to navigate investment risks.

  • Your mortgage interest rate is above the average return on safe investments like bonds.

  • You’re nearing retirement and want to reduce expenses.


Scenario 2: Low-Interest Mortgage and High Risk Tolerance


Mortgage holder profile:

  • Mortgage Interest Rate: 4%

  • Risk Tolerance: High

  • Financial Goals: Build wealth, leverage investments


If you’re in a low-interest mortgage, investing excess funds can be a smart strategy, especially if you have a high risk tolerance and long investment horizons:

  • Higher potential returns: Since 1900, the Australian sharemarket has returned an average of 13% annually. With a mortgage rate at 4%, investing could yield a net gain of 9%.

  • Opportunity cost of early payoff: Paying off the mortgage means missing out on the potential compounding growth of investments. Over time, this opportunity cost can be significant.

  • Liquidity: Investments offer greater liquidity compared to paying down a mortgage. If an emergency comes up, you can access funds from your portfolio, unlike equity tied up in your home.


This is ideal for mortgage holders that fit these criteria:

  • You’re confident in managing an investment portfolio or have access to a financial adviser.

  • Your emergency fund is fully stocked, and your overall debt-to-income ratio is manageable.

  • You have a long time horizon, allowing your investments to recover from potential market downturns.


Note that investment returns mentioned here are historical or hypothetical. Past performance is not indicative of future results, so kindly take into account the market volatility, potential losses, and the risk of capital depreciation.


Scenario 3: Balanced Approach Between Mortgage Repayment and Investing


Mortgage holder profile:

  • Mortgage Interest Rate: 5%

  • Risk Tolerance: Moderate

  • Financial Goals: Build wealth while reducing debt


A balanced approach blends the best of both worlds, allowing you to work towards financial freedom while building wealth. Here’s how this strategy works:

  • Split allocations: Divide your surplus funds, allocating a percentage to extra mortgage payments and the rest to investments. For instance, a 50/50 or 60/40 split between repayments and investments.

  • Leverage tax benefits: Contribute to tax-advantaged accounts like your super to reduce taxable income, while making extra mortgage payments save on interest.

  • Minimise risk exposure: By reducing mortgage debt, you lower long-term risks, but investments still offer potential growth.


A simple way to utilise this strategy is to:

  1. Use bonuses or windfalls for extra mortgage payments to save on interest.

  2. Invest monthly surplus funds in diversified portfolios for long-term growth.

  3. Review allocations periodically and adjust based on market conditions or personal goals.


But should you consider this approach? It’s ideal if:

  • Your mortgage interest rate is moderate, and your investment options yield higher returns.

  • You want a diversified approach to minimise financial regret.

  • You have competing goals, such as funding retirement, saving for a child’s education, or planning for future expenses.


Balancing Mortgage Repayment and Investing

Debt recycling is a great strategy to balance your mortgage payments while investing


By now, you probably would’ve already found your answer. If you decided to go for a balanced approach, there are more tips that you can use to maximise the benefits.


Refinance


In order to benefit from a balanced approach between repaying your mortgage and investing, you first need to make sure your mortgage is providing you with favourable loan terms. That includes having a low to moderate interest rate.


If you feel like your interest rate is high, your only option is to refinance. 


Koalify is a licensed mortgage broker that actively works with 30+ top lenders in Australia. Easily get personalised, unbiased mortgage refinance options based on your circumstances and goals with us.


And we do it at zero broker fees to you! Contact us today to discuss your options.


Debt Recycling


Debt recycling is a financial strategy of converting non-deductible bad debt (such as a home loan) into deductible good debt while simultaneously investing in income-producing assets. 


This method can help you pay down your mortgage faster while building an investment portfolio.


Here’s how it works:

  1. As you pay off the principal of your mortgage, you redraw or refinance a portion of the equity to invest in assets like shares or property.

  2. The interest on this new loan becomes tax-deductible since it is used on income-generating assets, reducing your taxable income.

  3. Over time, the returns from your investments can be used to further reduce your mortgage or reinvest for compounding growth.


This is a very good balancing strategy for individuals with a stable income, good credit, and long-term investment goals. 


But as much as it sounds tempting, debt recycling can also easily become very risky considering the marketing volatility and the potential for increased, uncontrollable debt. So, make sure to seek professional financial advice to ensure the strategy aligns with your risk tolerance and financial goals.


Utilise Offset Accounts


An offset account is a savings or transaction account linked to your mortgage. The balance in this account is calculated against your mortgage, which means your mortgage interest is calculated on the final amount that comes from the difference of your offset account balance and mortgage balance. 


When used wisely, it’s a neat way to save on interest while retaining access to your funds:

  • If you have a $400,000 mortgage and $50,000 in your offset account, interest is only charged on $350,000 ($400,000 - $50,000).

  • The more money you keep in the offset account, the less interest you pay, which also ultimately shortens the loan term.


Offset accounts offer great liquidity and flexibility for your money. As such, you can balance debt repayment with other financial priorities without committing funds permanently to your mortgage.


How? By directing all income and savings into the offset account to maximise its impact. The money you save on interest with the offset account can then be redirected towards investments elsewhere. 


Regular Financial Reviews


Naturally, financial situations and market conditions change over time. That means you need to constantly review your finances to ensure your strategy remains aligned with your goals and maximises your financial potential.


While you can do this yourself, we’d highly suggest you consult a legal professional or financial adviser to review your finances and adjust your strategy accordingly. The financial market is complex and fluctuating, so it’s worth running things by a certified professional.


Conclusion


We’re glad you made it to the end of this in-depth guide. It’s vital that you know where to put your money, so we hope this guide answered your question.


BUT—kindly consult a legal professional or a financial adviser to get a more personalised solution when deciding to pay off your mortgage or invest. This is your money, and you must do everything to make sure you use it wisely to not put yourself in financial risk.


We highly suggest you consider this guide only as a baseline and discuss with a professional for a personalised approach depending on your finances and goals.

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