Understanding the Trade-Off Between Mortgage Reduction and Wealth Building
Many Australian homeowners face a common dilemma: is it better to use spare cash to pay down your mortgage or invest for the long term? The answer isn’t straightforward. It depends on your personal circumstances, financial goals and your individual risk tolerance.
Key Factors to Consider
- Do you feel more secure reducing debt, or are you focused on growing your wealth through investments?
- Is it just about the numbers? It’s tempting to simply compare your mortgage rate to potential investment returns. However, this approach doesn’t account for risk or taxes.
Risk vs Risk-Free Return
Paying down your mortgage provides a guaranteed, risk-free benefit—effectively, a “risk-free after-tax return.” For example, if your home loan interest rate is 6.5% and you have $100,000 in your offset account, you’re effectively saving $6,500 per year in interest. This is comparable to earning a 6.5% after-tax return with no investment risk.
In contrast, investing that $100,000 in assets like shares or bonds, introduces risk and potential for loss. For many, gaining an extra 1–2% return isn’t worth the additional risk, especially when cash savings already offer a guaranteed benefit.
Don’t Forget Tax Implications
The $6,500 you save by offsetting your mortgage is an after-tax benefit. To achieve the same result by investing, you’d need a much higher pre-tax return—about 9.3% at a 30% marginal tax rate. That’s because investment income is usually taxable, while interest savings are not.
If you borrow against your mortgage for investing (making the interest tax-deductible), the calculation changes. For example, on $100,000 borrowed at 6.5%, you may save $1,950 in tax, but the strategy still carries risk and must meet strict tax rules.
When Does Investing Make Sense?
For investing to be worthwhile compared to paying off debt, your after-tax investment returns should comfortably exceed your mortgage’s after-tax interest rate. Meaning the higher your mortgage interest rate, the higher the level of return required to make the risk involved with investing worthwhile. Therefore, this strategy makes more sense in lower interest rate environments.
Debt Recycling: Combining Both Strategies
Debt recycling allows you to pay down your home loan while building an investment portfolio. Here’s how it works:
- Use extra cash to reduce your mortgage
- Borrow or redraw a comparable amount for investment
- Invest in income-generating assets (like shares or managed funds)
- Potentially benefit from long-term growth and tax-deductible interest
This strategy can improve tax efficiency and accelerate wealth building, but it suits experienced investors with stable incomes, equity and a high-risk tolerance.
Bottom Line
Paying off your mortgage offers a guaranteed, risk-free benefit. Investing can build long-term wealth, but only if you’re confident your after-tax returns will exceed your mortgage rate by a healthy margin and you’re comfortable taking on extra risk. Debt recycling may offer a balance, but it isn’t for everyone.
Let Us Help
If you are interested in discussing your options for investing, please contact Morgans Mackay today by calling (07) 4957 3033 or visiting the Morgans Mackay webpage.
Disclosure: The information provided above is based on an assumed marginal tax rate of 30%. Individual circumstances may vary, and you should seek personalised advice before making any financial decisions.
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