Owning your home outright is often a key financial goal for many Australians.
There are certainly many benefits to paying down your mortgage as quickly as you can.
But the big question is… should you be solely focused on paying your mortgage off early to save on interest costs or are there other ways to optimise the spare dollars you have?
Which goal is more important?
When it comes to deciding ‘Should I pay my mortgage or should I invest?’ – the first point you need to consider is – ‘Which goal is more important?’.
We realise that for some people they just want peace of mind… and being mortgage free will certainly help to achieve that.
There’s no denying that paying off your home loan quickly will help reduce the total amount you spend on interest, but it’s not necessarily a bad thing to maintain your mortgage for its full term if you put those additional funds to good use.
If you are determined to accumulate wealth and secure your financial future, it might be worthwhile doing some number crunching. Investing the money you would have utilised as additional repayments could make a significant difference to your overall financial position.
Compare the calculations
Right now we are experiencing some of the lowest interest rates ever seen and with the current state of the Australian economy, it’s likely that these low interest rates will continue for some time to come. This is where looking at the calculations could be helpful when deciding what’s best for you and your family.
Let’s take the example of a 30 year, $500,000 mortgage at a 3.5% interest rate. Current rates are actually lower than this but we have used it for illustrative purposes. Of course, if rates were higher or lower over the 30 year period the figures would change.
The Government’s Moneysmart online mortgage calculator indicates that the monthly repayments on this mortgage would be $2,245.
We’ve excluded fees in this scenario as they are always variable, depending on the lender. At the end of the 30 year term your mortgage would be paid and you would have incurred $308,280 in interest.
If you paid an additional $500 each month, you would pay the mortgage off in 21 years and 9 months and only pay $214,168 total interest – more than eight years sooner and $94,112 less.
But, if you had invested the $500 each month, and the average return on the investment was 7.5%, compounding interest could dramatically increase the results over the 30 year period.
The Government’s Moneysmart compound interest calculator indicates that your investment would be worth $678,433 at the same time that your mortgage would be finalised.
In this example there is a staggering $584,321 difference between the amount of interest you saved on your mortgage and the investment you have grown.
Even if the interest rates increase during the life of your mortgage, the return on your investments could still be the greater amount.
While the calculations we have just outlined do portray a positive example, there are personal considerations to take into account.
It all comes down to what you are most comfortable with. Whether you pay off your mortgage or you invest, both can help you increase your assets.
The real difference lies in reducing debt versus diversifying your overall wealth.
Of course, you should also think about your lifestyle… if you are closer to retirement then you might make different choices to someone in their early thirties.
Plus, your marginal tax rate can also influence your decision. Higher income earners might find their investment income is taxed at a higher rate, so paying down their mortgage might be a more appropriate option. A financial adviser can help you analyse the options and decide what’s best for you.
Find the best rate
Finally, regardless of whether you choose to pay your mortgage off early or invest in the share market, it’s always worthwhile making sure you have the best interest rate available.
Compare what’s on offer between home loans and don’t be afraid to move to another, more competitive lender.
It’s the first step in reducing the amount you pay in interest.