It’s always a good idea to regularly check in on your financial position, whether there’s been a significant change in your financial situation or not. And 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?”.
The age-old question: pay down your home loan or invest elsewhere
For most, there is nothing like the comfort of reducing their mortgage. Knowing they are building ever more equity in their own home and moving just that little bit closer to owning their own home outright.
Paying off your home loan is risk-free, unlike investing. It’s easier to commit to mortgage payments than regular investments.
The benefits of paying down your home loan: reducing risk and taxes
In addition, there is a significant tax benefit. Reducing your mortgage saves you untaxed money, while earnings from investments are likely taxed at your marginal tax rate.
If returns from investments exceed low-interest rates, it’s smart to invest beyond the 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 assets held within super is a benign 15 per cent, which for most people is below their marginal tax rate.
The benefits of investing elsewhere: diversifying your assets and potentially higher returns
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 asset pool. Diversify your asset pool by investing additional funds in fixed-interest investments, commercial or domestic/international shares.
Crunching the numbers: comparing savings from paying down your home loan versus investing
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 per cent.
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% per cent, 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.
Seeking advice from a financial planner: finding the best mix for your financial situation
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 per cent 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. A Financial Planner is the best person to help you decide just what the best mix is for you.
Visit our website to learn more or book a cost and obligation-free financial planning appointment today.
Sources:
MoneySmart, https://moneysmart.gov.au/home-loans/mortgage-calculator Mortgage Calculator (accessed 29/12/2022)
MoneySmart, https://moneysmart.gov.au/budgeting/compound-interest-calculator Compound Interest Calculator (accessed 29/12/2022)