Pay off the mortgage faster or invest? Here is my strategy …
After almost two years with a mortgage, I have developed a focus on my living expenses and am very confident that I can comfortably repay my debts.
I also know that, mortgaged or not, I can still take advantage of the tax-free capital gain on the value of my property. It’s locked up.
I also live in a property that I am happy to retire in, so there is no need for me to accumulate equity in this location to be able to move to another.
While I would still like to own my home when I retire, I realized that I would also like to own many other assets to support my standard of living when I stop working.
Thus, I no longer rush to be “debt-free” and instead invest my monthly savings regularly, combining as much as possible my tax-efficient super contributions and also investing directly in stocks. (I’m also looking to borrow more to invest in real estate, but that’s a story for next week. Stay tuned.)
Of course, taking on a higher level of debt means taking on more risk. If you lose your job or can’t make payments, you can have all kinds of problems.
But higher risk is also associated with higher returns, over the long term and following a sufficiently diversified strategy.
It is true that paying off my mortgage faster would mean that I would end up paying less interest to the bank over the (shorter) term of my loan than otherwise. However, this savings must be weighed against the potential gains to be obtained by investing the surplus savings elsewhere.
Ultra-low interest rates have drastically changed this equation in recent years.
It’s easy to forget that just a decade and a half ago, before the Global Financial Crisis (GFC), mortgage holders were paying interest rates of 8% or 9%.
Mortgage interest payments as a percentage of disposable income peaked at 10 percent just ahead of the GFC, according to figures from the Grattan Institute. They have since fallen to around 4 percent as rates have fallen to record highs.
The truth is, once you’ve stepped in the door with a big enough deposit, the cost of running a mortgage has dropped dramatically – back to what it was in the 1980s and 1990s. (the property was cheaper back then, but the interest rates were much higher).
Today’s ultra-low interest rates (mine is stuck at 1.84% for two years) have two important consequences.
First, as we have seen, they make the mortgage service much cheaper.
The second impact has been to massively inflate asset prices – both real estate and stocks.
Why? Because people are rushing around and borrowing a lot of cheap money to buy assets, inflating their prices.
How long can this last? Well, it depends on how long the interest rates stay so low.
The Reserve Bank of Australia has said it does not plan to raise official interest rates until 2024.
Global markets earlier this year flirted with the idea of a post-pandemic global inflation boom. However, COVID-19 continues to cast its long shadow.
Even once we emerge from the cloud of coronaviruses, we can only return to a world of ‘secular stagnation’ and lukewarm wage growth that came before it, driven by deeper forces such as an aging population.
So yeah, I guess I’m taking a kick that this story needs to go deeper, lower interest rates pushing up borrowing levels and prices. If that perspective changes, I will revise. You have to make up your own mind, borrow and invest accordingly.
A common thing I hear is, “I’m just going to pay off the mortgage and then I’ll start investing seriously for retirement.”
And yet, by delaying the purchase of investments for 10 to 20 years, people miss out on potential capital gains during that time, not to mention the magic of compound returns.
Ultimately, it comes down – as always – to your goals and your tolerance for risk.
But for those with substantial mortgage reserves and plenty of time before retirement, it may be worth revisiting your wealth building strategy.
- The advice given in this article is general in nature and is not intended to influence readers’ decisions regarding investments or financial products. They should always seek their own professional advice that takes their personal circumstances into account before making any financial decisions.
You can follow Jess’ more financial adventures on Instagram @moneywithjess and sign up to receive her weekly newsletter via The Age here or the Sun-Herald here.