Should I pay off my mortgage or invest? It’s a superannuation question Money is commonly asked and right now, with rates at rock bottom and rental and dividend yields on the slide, you may think it’s a no-brainer – put everything in the mortgage to have a guaranteed rate of return of around 4% versus an unknown rate for shares, property or superannuation. But that’s not entirely correct.
Whether focusing on your mortgage or investing is the better option depends on several factors, including your age, cash flow and appetite for risk, plus interest rates and investment returns. If you’re willing to take on more risk and have decent cash flow there are benefits to diversifying and investing wisely in other assets.
“Essentially, you have multiple assets growing together creating wealth faster – but not without greater risk. And in times of low interest rates, growth assets tend to perform strongly, as we’ve seen with property in recent years,” says CEO of Henderson Maxwell, Sam Henderson.
Paying off your mortgage gives you a return equal to the rate on your loan – and it is tax free. For example, if you are paying 4.5%pa interest on your home loan then 4.5%pa is your guaranteed rate of return. Chances are you can you do better than that – even if you take tax into consideration – but you must be prepared to take on risk.
“Managing risk is an essential to the success of the investor,” says Henderson. “Time and patience are also important. You need to be able to ride out inevitable cycles in all asset classes and time is your friend.”
There are times when it might make more sense to focus on reducing your mortgage rather than diverting extra cash towards investments. “People who have modest income and who are averse to risk should focus on paying off their mortgages,” says Henderson.
So if finances are tight and you’re anxious about taking on extra debt, then this might not be an option for you. It also pays to think about how much equity you have. A rule of thumb is that you should have 50% equity in the family home before you invest extra money in other assets.
At the end of the day, by concentrating just on your home loan you may sacrifice after-tax returns that are better than your mortgage interest rate. Get the strategy right and it could be very worthwhile. Get it wrong, though, and you might wish you had kept things simple.
