On the money Pay off the mortgage or invest elsewhere?

SHOULD YOU PAY OFF THE MORTGAGE EARLY OR INVEST ELSEWHERE? FINANCE EXPERT EFFIE ZAHOS TACKLES THIS BIG QUESTION

Okay, so you found an extra $50 per week in your budget and you’re not sure whether you should pop that into your mortgage or invest it elsewhere. Of course, there is no ‘one size fits all’ approach but chances are in a low-rate environment, as we are in now, growth investments, including super, could give you more bang for your dollar. Paying off your mortgage gives you a return equal to the rate of your loan – and it’s tax free. If you’re paying 3% per annum interest on your home loan then 3% is your guaranteed rate of return. Let’s say, for example, you opt to invest your extra cash into the share market. According to Vanguard, Australian shares returned 7.9% per annum on average over the 10 years to December 31, 2019.

POPPING IT INTO YOUR SUPER FUND

According to Chant West, balance super funds have returned 6.4% per annum over the past 10 years to February 28, 2021 and high-growth funds have returned 8.6% per annum over the same period. It’s important, however, to factor in tax, which can reduce that return. If the investment returns are 8% and your marginal tax rate is 34.5% (including the Medicare levy), your after-tax return will be 5.24%. That is still higher than mortgage rates at the moment. This doesn’t apply to super because investment earnings generated by your super are taxed at a maximum rate of 15%. Addressing the following points will help guide you to be financially fit.

WHAT’S YOUR MORTGAGE BALANCE?

If your mortgage is ‘fresh’, it can make sense to focus on that. That’s because when you take out a loan, interest accounts for a larger proportion of your repayment than principal so the more you pay off earlier, the less interest you’ll pay over the long term. A general rule of thumb is you should have 50% equity in the family home before you start investing extra money in other assets.

THE AMOUNT YOU HAVE IN SAVINGS

It’s important to have some sort of cash buffer in case of an emergency before you start investing.

HOW MUCH TAX YOU’LL NEED TO PAY

When you are looking at the potential returns of investments, you should factor in the amount of tax you need to pay on any investment income. You may also have to pay capital gains tax if you sell the investment for a profit.

INTEREST RATES

What rate are you paying on your mortgage and do you think you could get a higher rate of return if you invest elsewhere?

WHAT MAKES YOU COMFORTABLE?

You might prefer to buy your own home before you start building wealth in other asset classes.

ACCESS TO YOUR MONEY

If you think you’ll want access to your money in the next couple of years, it might be better to pay off your mortgage and have the money available through redraw or offset. If you have the money invested in shares or an ETF (Exchange Traded Fund) you may still be able to access it, but if you need it in a hurry and markets are down you may end up having to lock in any losses. And, of course, you’ll have an even longer wait if you want to take money out of your super.

“IN A LOW-RATE ENVIRONMENT ... GROWTH INVESTMENTS, INCLUDING SUPER, COULD GIVE YOU MORE BANG FOR YOUR DOLLAR” ~ EFFIE ZAHOS