Should you invest, or finish paying off your mortgage? That is the question. In this article, Mortgage Broker and Licensed Financial Adviser ROD LINGARD gives insight and unpacks this common question.
The new year is here and no doubt many of us have made New Year’s Resolutions, some of which may revolve around money.
One of the questions I am asked most often is “should I pay the home loan down before I start to invest?” The answer to that question is complex, and there are a number of things to consider.
Paying the Home Off First
For starters, here are some reasons to pay the home off first.
Having the home loan paid out provides significant peace of mind. Owning your home outright means no worries ever about foreclosure.
This may in turn lead you to feel more confident about your overall financial situation if a lender no longer has a claim to your home.
You’ll save on interest. You can save a lot of money by making extra payments to your home loan.
If you have a $300,000, 30-year loan with an interest rate of 4.5%, you’d pay around $1,520 monthly.
If you increased your monthly payment to $1,820, you’d save almost $80,000 in interest and pay off your loan eight years and six months before the scheduled payoff date.
Paying a loan off means you generate a guaranteed return on investment. As above, you will save on interest and as such you effectively generate a return. The return isn’t reliant on the performance of the investment.
Due to the ‘guaranteed return’, you may be more motivated pay off a loan. The thought of spending to invest in a potentially volatile investment may make you uncomfortable.
So there’s some compelling reasons why you should pay off your home – what about the other side of the coin.
Should you pay off, or invest?
The most important concept is what economists call ‘opportunity cost’.
Every dollar devoted to paying extra on your mortgage is a dollar you can’t use for another financial goal.
Since most of us have a limited amount of money, paying more on a mortgage that has a low interest rate may not make financial sense. This is especially true if you fail to take advantage of other opportunities, such as making a concessional contribution to superannuation.
Again, using the principal of opportunity costs, if the returns available through investing, whether that be property, shares, or anything else for that matter, are higher than the cost of funds, then investing may provide a better long term outcome.
So I still haven’t answered the question!
There is no right or wrong answer, as every individual will put a different weight on the various factors.
From my point of view, the best way to answer that question is to meet with a financial planner and do a break even analysis.
This is a process of establishing how much could I save if I paid off my home loan faster, compared to what outcomes are possible if I invested that money instead?
By doing a break even analysis you can determine a number of things;
- The balance of your home loan at any given point in time given a known interest rate and repayment
- The interest saved by the extra repayments can be identified
- From there, the return on any given investment required to ‘break even’ can be determined.
Putting all that in plain English – quite simply, from a financial point of view, if you come to the conclusion that the return on the investment will be more than the interest saved, then you should consider investing rather than extra payments to the home loan.
I’m always happy to help anyone with an obligation free break even analysis.
Rod Lingard is a Mortgage Broker and a Licensed Financial Adviser at Lifestyle Connexion and can be contacted on 07 3240 4800 or 0400 160 461. Financial Advice is provided by Rod Lingard – Authorised Representative No: 248734 of Hunter Green Pty Ltd | AFSL No 225962.
General Advice Warning: This blog is not designed to replace professional advice. It has been prepared without taking into account your objectives, financial situation or needs. You should consider the appropriateness of the advice, in light of your own objectives, financial situation or needs before making any decision as to what is appropriate for you.