Client Q’s: Should I pay down the mortgage or invest?

 by Mike Ross at Evergreen Advice

Of all the questions we get from clients 'Should I pay off the mortgage or invest' is one of the most common, and we have heard it more frequently as mortgage rates have increased.

Our response can be broken down into two areas: basic rules that are true for everyone, and areas that are more personal preferences.

The Basics

If you have additional funds, over and above your mortgage payment check, first check that your financial house is in order.

1. Optimise your KiwiSaver: Make sure you are taking advance of KiwiSaver benefits that are available to you including:

• The government contribution and
• the compulsory employer contribution

This gives you a guaranteed initial return of 50%+, even if you can’t access that return until you’re 65.

2. Pay down any high-interest debt, such as your credit card balance, a car loan, and any other personal loans. Interest costs on this debt can be well above 10%, and so paying it off is a risk-free return that is (likely) better than the investment or mortgage payment you will make.

3. Build an emergency fund: An emergency fund is savings set aside in case you lose your job or an unexpected major expense comes up. Note that if you have a mortgage then a revolving mortgage can act as your emergency fund, providing you with some flexibility in case of emergency, and ensuring you don’t have to pay additional interest.

4. Understand your mortgage: Factors such as your current interest rate and repayment restrictions can help you decide whether investing or paying off your mortgage is best. You may have locked in a low mortgage rate in 2021, when interest rates were at historic lows. This could make investing more attractive given how low your interest payments are.

There also may be a limit to how quickly you can pay off your loan, with break fees if you want to pay it back more quickly. These factors should all be considered as part of your decision.

5. Invest appropriately: If you’re going to invest make sure you’re investing in something that has a reasonable probability of achieving a return above the interest cost on your mortgage. There’s little to no point in investing in term deposits, or even a conservative fund, which are likely to have a return that’s lower than the cost of your mortgage. This means investing predominantly in growth assets such as shares.

With mortgage rates currently around 6%, an investment needs to return more than 6%, after fees and taxes, to provide a better return than paying down your mortgage. Over the long-term shares have delivered a return of 8%-10% per year (6%-9% per year after fees and tax), though remember that the ride will be bumpy.

What is your preference? 

Discuss this topic with a few people and you’ll find very strong opinions on either side: become mortgage free as quickly as you can, or invest the funds into shares and property to maximise your returns. But, like most financial decisions, you should make the choice based on your own situation, goals, and risk appetite.

Team Pay down the mortgage

Becoming mortgage-free can be a millstone for many people. Mortgage payments are a constant expense, can be a source of worry and the day you pay off your mortgage is often a goal to be celebrated. If this sounds like you then concentrate on paying down the mortgage. Don’t worry that you could get a higher return out of investing in shares – pay down the mortgage and then you can turn your mind to investing.

Team Invest

Investing will likely give you a better return. If you can handle the volatility of markets then in the long run you’ll be better off. Investing also provides diversification meaning that your total net worth won’t be tied up in your house and provides you easier liquidity if you want your funds relatively quickly. Finally, investing can give you valuable experience so that when your mortgage is paid off you know how to invest that extra money.

Team Why not both?

It doesn’t have to be one or the other. If you’re on the fence a potential solution might be to do both. This also might allow you to slowly get comfortable with investing before committing to that team.

What this means for you

The decision as to whether to pay off your mortgage more quickly or invest is a personal one based on your specific circumstances and preferences. One approach may suit you, or a balance of the two. But remember to take care of the basics first – KiwiSaver, high-interest debt, and your emergency fund.

For more on the subject, including a calculator to help you run the numbers, we suggest this article by Crayon, a site that provides a financial roadmap for every stage of parenthood.