INSIGHTS

Should I pay off the mortgage faster, or use that extra cash to invest?

This is always a common question, but it’s especially relevant today.

Mortgage rates are at 15-year highs, with borrowing costs at levels many homeowners won’t have experienced before.

Paying down the mortgage as quickly as you can is sensible, and it’ll set you on the path to financial freedom.

However, it’s not black or white and using some of that spare money to invest along the way will also pay off.

The advertised one-year fixed mortgage rate is 6.7 per cent at the moment, so if you make additional payments on your mortgage, that's essentially the annual return you're getting on that money.

Your other options for putting those funds to work will give you a varying range of returns.

Term deposits are a very low risk option, and the one-year advertised rate is sitting at about 5.7 per cent right now.

Other assets like managed funds, property and shares will offer much better returns than this, albeit with a higher risk profile and more volatility.

If you prefer to listen to a podcast episode on this topic: 

Alternatively, search 'On Point Podcast' and listen via Spotify or Apple Podcast. 

New Zealand shares have delivered an annual return of 9.1 per cent since the NZX 50 index came into being in early 2001.

That’s well above the current cost of borrowing, and much higher than where mortgage rates have been for the bulk of the past 25 years.

It’s an average return over that period though and just like any growth asset, those gains don’t come consistently or in a straight line.

The sharemarket has had numerous ups and downs along the way, including three bigger declines of more than 20 per cent.

Those came in the wake of the GFC in 2008 and 2009, again during the Covid-19 pandemic of 2020, and then from early 2021 until the middle of last year, amidst surging inflation and sharp increases in interest rates.

Markets always recover, and in hindsight we often look back on those difficult periods fondly because of the opportunities we were able to take advantage of.

However, they can be highly disconcerting at the time.

In contrast, the "return" one gets from paying down the mortgage is free of risk, volatility and uncertainty.

If you're paying that one-year fixed rate of 6.7 per cent, the interest that you’ll save isn’t at the mercy of economic conditions or market sentiment, it’s guaranteed.

That's why the textbook, a spreadsheet model, and your accountant will usually suggest paying down the mortgage.

There's nowhere in the investment world where you'll find a similar return, for zero risk.

But it’s never that simple, and that’s not always right for all of us.

Doing a bit of investing on the side can be a very good choice for many people. The knowledge gained by educating ourselves about money, shares and financial markets can be invaluable.

When we have skin in the game, we often take a much greater interest in something.

Having a few investment interests, even small ones, might give you the motivation to follow companies more closely, read the business pages more often, and understand how financial markets work.

While you're unlikely to find a better risk and return proposition than making additional mortgage payments, you'll learn a lot and put yourself in good stead to make better decisions in the future.