Are you weighing the benefits of paying off your mortgage faster than investing surplus money?
Whether you are a seasoned investor or just bought your first family home, there are a few things to consider.
Mortgage payments comprise two components: interest on the loan and a principal amount that pays down the total outstanding balance.
The higher the interest rate, the more significant the amount remaining on the loan in the last ten years.
Consider the interest cost that could be saved by paying off a mortgage ten years early compared to earnings from investing the money in the market.
The rate of return earned from investing might exceed the interest you’d pay on the mortgage over the final ten years of the loan.
Let’s use the example of a 30-year $500,000 home loan with a 6.24% standard variable home loan rate. The total interest paid over the years will be $607,121. If you paid an additional $577 per month, you could save $230,706. This will pay your mortgage back ten years earlier.
However, depending on your mortgage type, there could be limits to how much you can repay in a given period.
Alternatively, if you have an initial investment of $120,000 and contribute $500 monthly at a compounded interest rate of just 1% higher than your mortgage rate, you could make $334,677.
Your goals will impact the path you take. So firstly, be very clear with what you are working to achieve. Of course, you should also think about your lifestyle. Do you want to build your portfolio for retirement income or have enough equity to buy your eldest a car?
We explore the advantages of both strategies while shedding light on the approximate timelines for Return on Investment (ROI).
Both options have merits, and the choice largely depends on individual financial goals and circumstances.
Considerations for Accelerated Mortgage Repayment vs. Investment Focus
1. Capital Growth
Mortgage Repayment
By prioritising mortgage repayment, you reduce the interest expenses, leading to substantial savings in the long run. This can translate into improved cash flow, providing a stable financial foundation for future investments. This approach is a secure and steady path, but it can often take 10-20 years to own your home. It ensures you secure your family’s shelter and build home equity over an extended period.
Investment
In today’s economic climate, investing in other assets can offer quicker capital growth, especially if you make well-informed investment decisions. However, there’s a risk that some or all your money could be lost if you decide to invest your money in the market instead of paying off your mortgage. ROI can often occur within 3-10 years and will provide a different level of security than homeownership.
Investing in shares or fixed-income securities is one of many ways to diversify your holdings. Not only can this help you potentially build your wealth, but it could offer some protection if the residential property market reduces in value.
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A balanced approach is often ideal. Focus on paying down mortgage debt while making strategic investments to leverage your capital for growth.
2. Negative and Positive Gearing
Mortgage Repayment
Paying off your home loan typically shifts your property into a positively geared scenario in the long term. This means your home-related expenses are lower than your rental income, providing you with financial stability over time. This shift can take place over approximately 2-5 years.
Investment
Investing in additional properties may lead to negative gearing due to higher expenses. While this allows for tax deductions, it may strain your finances in the short term. The turnaround to a positive cash flow is usually around 5-10 years, depending on market conditions.
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The best outcome is transitioning toward positive gearing over time while maintaining a diversified portfolio.
3. Rental Income vs. Selling
Mortgage Repayment
Paying off your mortgage early means earning passive income without mortgage-related expenses. This substantially bolsters your cash flow and can be realised once the mortgage is cleared. This secures your housing and frees up funds for other investments or children’s education. Selling your house would also mean the lump sum could be utilised differently.
Investment
Holding onto multiple investment properties and collecting rental income provides a steady passive income stream. Alternatively, they sell properties when favourable market conditions can result in substantial returns, typically within 2-7 years. Real estate investments can come with fees that add to the expense of the asset. Ensure you evaluate the total long-term impact.
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Balance your strategy by securing your family home while investing in properties that generate rental income. Remember to consider selling when market conditions align with your objectives. This can optimise returns regardless of the Australian economy.
4. Financial Property Tax
Mortgage Repayment
Lowering your mortgage balance reduces interest payments, resulting in fewer tax deductions. Over time, this effect becomes more pronounced, with a significant impact on taxes typically experienced after 5-10 years. Unfortunately, you can’t claim investing tax benefits on the mortgage on your home, as it’s viewed as your principal place of residence. However, knowing you are closer to owning the property, you’ll have peace of mind.
Investment
Maintaining a mortgage allows for consistent tax deductions, effectively reducing tax liability. You can claim tax benefits, including interest on the investment property loan and depreciation on fittings and fixtures. This strategy offers immediate tax benefits.
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Consult a tax professional to optimise your tax strategy, considering your investment horizon and mortgage repayment timeline.
The Bigger Picture Of Your Wealth-Building Strategy
The choice between accelerating mortgage repayment and investing hinges on your financial goals and risk tolerance.
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.
Balancing the need to secure your family’s home and grow wealth for your children’s future requires a thoughtful approach.
Striking a balance between these strategies is advisable. Align your long-term objectives while seizing opportunities for quicker ROI in the current market conditions.
It is imperative to seek guidance from financial experts well-versed in the Australian property landscape to make informed decisions tailored to your unique family circumstances and aspirations.
Make sure they look at your complete wealth-building strategy to ensure you’re not missing opportunities to build wealth elsewhere.
AFP Financial Planning & Consulting has partnered with Advice Intelligence to help you determine the best route to your goals.
Follow the steps to start your WealthMap journey on our website.
