This is one of the most common questions that I get as a financial planner. As a general rule, I like people to have something compounding & growing over time as this is a key pillar of financial independence. There is no ‘one size fits all’ solution to this question though. In this article, I will go through some things to think about to see which option is more beneficial for you.
It’s always a good idea to regularly check in on your financial position. For those who find themselves with spare funds, it often raises the question, “Should I pay down my home loan or invest these funds elsewhere?”.
For most, there is nothing like the comfort of reducing their mortgage. Knowing you’re building ever more equity in your own home and moving just that little bit closer to owning your own home outright.
What’s more, repaying your home loan feels less risky, in the way there is risk attached to investing in the market. Somehow, it just seems that much easier to commit to paying more off your home loan, than strictly setting aside an amount each month to invest.
In addition, there is a significant tax benefit. The money you save by reducing your mortgage and lowering your overall interest rate bill is not taxed, while any earnings or capital gains received from investments will most likely be taxed at your marginal tax rate.
Against that, there is a good argument that if you can generate returns from investments in excess of this rate, then the smart money is on making investments beyond your home. Especially if you contribute these extra savings to your superannuation fund and then invest the funds within superannuation. This is because the associated tax rate for earnings within super is a maximum of 15 percent, which for most people is below their marginal tax rate.
In addition, you might be able to reduce the tax you are paying on your weekly earnings. Again, depending on your situation, you can contribute up to $27,500 a year to super and potentially claim a tax deduction for these contributions or up to $110,000 a year using after-tax income or savings.
Investing funds outside of your home also means you are diversifying your assets. Rather than having all your funds tied up in one property, you can choose to invest any additional funds in a range of opportunities such as fixed-interest investments, commercial property, domestic shares, or international shares.
But just how do the numbers stack up? Just what sort of returns can you get from investments compared to repaying your own home loan?
Let’s assume you take out a $500,000 home loan over 30 years at say 3.5 percent.
The Government’s Moneysmart online mortgage calculator suggests monthly repayments would be $2,245 and the total interest charged would be $308,280.
If you repaid an extra $500 a month to reduce this loan, you would reduce the term to 21 years and nine months and the total interest bill would be just $214,168 – saving you some $94,112 in interest payments.
Alternatively, if you invested $500 a month in an investment generating 7.5% percent per year, at the end of 30 years, the Government’s Moneysmart compound interest calculator suggests this investment would be worth $678,433. That’s $584,321 more than the interest you’ve saved.
The numbers suggest overwhelmingly that you are better off investing outside your own home if you are confident that you can commit to this investment strategy, and if you are assured, you can obtain at least 7.5 percent after tax year after year for 30 years.
For most people though, the best strategy is a mix of repaying your home loan early, contributing extra funds to super, and, building up an investment portfolio.
To find out the ideal mix & create a plan that is based on your unique situation, we have created the Finnacle Financial Blueprint. This allows us to model your current situation & multiple scenarios to see what the outcomes are and see which one is the ideal one for you. The financial projections will show the growth in your money over time, as well as being able to factor in things like holidays, upgrading your home, or having another child to see how that will impact things.
If you would like to know more about the Financial Blueprint, click here. From there you can join the waiting list for our Financial Blueprint program, and access some of the tools that we use with our members!
To discuss more about what we do and if we can help you on your financial journey click here to organise a quick phone call with me 😊.
