Disclaimer: This post is NOT financial advice or a recommendation about what you should be doing – merely an exploration of my thoughts on the topic.
Does it make more sense to focus on paying off my mortgage(s) quickly, or to invest that money instead? Or is it best to do a bit of both at the same time?
This decision depends on your goals. The greatest overall return would be to pay the minimum on the mortgage and to invest the difference, as historically investment gains tend to be greater than mortgage interest rates. Additionally, the value of the mortgage decreases over time relative to inflation, so you are effectively paying less by paying the mortgage off with future money.
Say your mortgage interest rate is 6% (which is pretty common for PPOR at the moment). And let’s keep the mortgage amount round at $1million, even though this is quite a large mortgage! This means you’re paying a whopping $60,000/year in interest. (A little less as the interest reduces as the loan is paid down, but let’s keep it simple). Now the past few years, inflation has been around 6% in of itself, though on average it’s closer to 3%. Taking the lower value of 3% – next year’s $60,000 interest is equivalent to $58,252 in today’s dollars. In 5 years. $60,000 is equivalent to $51,757 in today’s dollars. In 10 years, that’s $44,646 in today’s dollars. And in 20 years, that same interest is only $33,221 in today’s dollars. This is what I mean by saying that the value of your mortgage goes down with inflation. Note that this also applies to principal payments you’re making on the mortgage!
However, the psychological benefit of owning your home outright needs to be taken into account. Also, mortgages leave you at the mercy of fluctuating interest rates, and carrying the mortgage can make cash flow tighter. My mortgage payments have doubled over the past two years due to all the interest rate rises. Fortunately, I borrowed within my means and was able to afford the higher payments, but it certainly made cash flow much tighter, even with a DINK household!
What if you split the difference? Allocate an extra $X/month into the mortgage, but the rest of your savings get diverted to investing? This way you make some progress towards paying off your mortgage sooner, but also derive the benefits of being invested in the market.
This is essentially the tactic I have been using, but there are some caveats to keep in mind if doing this. The first is that the overall return on net worth is less than if you were fully invested. The second thing to keep in mind is that even if you are paying extra into the mortgage, your monthly minimum repayment remains the same. So until the mortgage is fully paid off or otherwise refinanced, you don’t get to see the cash flow benefits of paying down on the mortgage.
Honestly, I feel like I’ve talked myself out of paying extra to the mortgage today! I still want to knock out the smaller portion of it, as I can pay it off within a few years and free up the cash flow, but it just doesn’t make sense to me to spend the next 15 years fast paying the mortgages in preference over investing. I’m going to redo my loan amortisation schedule and revisit what option is best!
Chasing FIRE Down Under 