Should you pay your mortgage or invest?

A common question we are asked as tax and financial advisers is whether it’s best to pay off the mortgage first and leave investing until later, or to focus on both simultaneously.

The best option for you will depend on your specific circumstances, but here is a general analysis of the outcomes of both strategies.

Focusing on paying off your mortgage

Advantages

1. The faster you pay your mortgage, the less interest is paid to the finance provider. It is also the easiest option to implement and understand.
2. Under Australian tax law, a principal residence can be disposed of without any capital gains tax being applied. By reducing the mortgage, you are building wealth in an environment free from capital gains tax. 
3. If you use an Offset Account, you can save money in an account that effectively earns a relatively high interest rate and is free from income tax, you can also have at-call access to your cash if you need it.

Disadvantages

1. Despite the tax effectiveness of paying down a principal mortgage, you are concentrating your wealth in one lifestyle asset, which can be an adverse strategy purely due to the lack of investment diversification.
2. The longer it takes to get the mortgage under control has a consequence. It might mean you do not have enough time to build an investment portfolio with which to live off in retirement. If this is the case, it might mean having to sell the property and downsizing.
3. Property values can go down and can dilute the level of equity you have in your home.
4. Without adequate asset protection strategies in place, any equity you have in your principal residence could be at risk in the event of future ill-health or litigation.

Investing in a portfolio of shares and managed funds while making lower mortgage payments

Advantages

1. Although your mortgage won’t be reducing quite as quickly as the first option it will still be coming down and in addition, you will be building up a portfolio of other assets that are likely to provide a good level of overall diversification.
2. Recent research suggests that gross returns from residential real estate and equities is similar, however, equities are more volatile. 

Disadvantages

1. Investments exposed to the share market are subject to market fluctuations. It is important to take a long term approach that can cope when investment markets perform poorly. The longer the time horizon, the better the opportunity to recover from the poor years which must come for every asset class.
2. Shares and managed fund assets are subject to income tax on any distribution or dividends, plus capital gains tax may apply when you sell the assets.
3. Not many people would like to be paying a mortgage with their retirement income. Generally speaking, the closer you are to retirement the more sense it makes to pay off your mortgage as a top priority.

Every situation will have a different outcome, so contact us to discuss the strategy that best suits your financial needs and goals.