21 June 2021

    Pay down extra on the mortgage or invest?

    The million‑dollar question

    Nicholas Smith

    Senior Wealth Management Adviser (Christchurch)

    Nicholas Smith

    Senior Wealth Management Adviser (Christchurch)

    So, you’ve got some extra cash each month – maybe from a pay rise or an expense that has reduced (the kids have finally moved out!). First off – that’s great news! You’re now ready to start directing that extra income surplus somewhere. But should you pay down the mortgage or invest?

    This is a common question, and depending on your personal circumstances, one may be more appropriate than the other.

    Investing can make sense if you earn more on your investments (after tax) than your mortgage interest rate

    We’re currently seeing very low mortgage interest rates (under 3% in most cases) in New Zealand, which are generally expected to remain low for some time yet. In contrast, we’ve been seeing very good returns from the share markets here and around the world (for example our NZ Growth Fund has returned nearly 13% per year on average since 1998!).

    This might seem like an obvious case for investing your spare cash rather than paying down the mortgage right? You can pay the bank their 3% interest and still end up putting your extra money to use and you will be well ahead with your investment returns. But most investment returns are illustrated as ‘averages’ and we can’t forget about volatility; the markets don’t tend to behave like a term deposit. Your investment might be up 20% one year, then down 10% the next. It is unlikely that you will actually receive an ‘average’ return an any given year. Over the long term investors can expect strong returns from the share market, but we can’t be sure what will happen in the short term.

    So you need to consider your own personal risk tolerance. Would you be comfortable with the ‘ups and downs’ or would you lay awake at night stressing?

    One thing to remember about investing is the power of compound interest over time. The sooner we start investing, the longer we have in the market for compounding to take effect. If you are comfortable with some volatility along the way, then investing rather than paying extra off the mortgage may be an appropriate strategy for you.

    “The best time to plant a tree was 20 years ago, the second best time is now” - Chinese proverb.

    Paying down the mortgage makes sense if you value the ‘peace of mind’ of being mortgage-free.

    Depending on the structure of your current mortgage, you may need to check with your lender to ensure there are no penalties for early repayment. Generally, fixed term mortgages would incur a ‘break fee’ if repaid early whereas floating or revolving credit arrangements would not carry these types of fees so could be paid off early at any time.

    Paying off the mortgage is a liberating experience – you’re finally free from the bank! You no longer have the regular payments coming out of your account and can divert these to your investments or lifestyle instead.

    It can be said that paying down debt is a ‘guaranteed return’, and it is unlikely you’ve ever heard anyone say “I wish I hadn’t paid off my home sooner”. However, we do need to consider some of the downsides:

    • You will end up with a large proportion of your wealth/equity ‘locked up’ in your home. Your home is generally not an income producing asset, so you become ‘asset rich, but cash poor’. You can’t sell a few bricks to pay for the groceries

    • Houses are not particularly liquid either, usually taking quite some time to sell. Again, this means you are not able to access your wealth easily

    But if you really want to be mortgage free, then you can shave years off your mortgage by contributing more than the minimum and then be in a situation to be able to divert your surplus and your repayments into an investment. If you value the ‘peace of mind’ that paying off your mortgage produces, then this may be a good strategy for you

    Beware of lifestyle creep. While some people do pay off their mortgage and then start investing, we also see a lot of people that just ‘buy more house’ as they progress through life (taking on more debt as they go). Investing on the other hand leads to a good lifetime savings ‘habit’ and can help prevent the allure of a bigger house - and put you in a better position to fund your eventual retirement.

    Hedging your bets – why not do both?

    The decision to pay down extra on the mortgage or invest is a very personal one, and depends on many factors unique to your situation

    This may sound like a bit of a cop out solution, but a combination of both strategies does make sense in a lot of situations. You still reduce the time it takes to pay off your mortgage, but you also benefit from the compounding effect of investing early and improve your overall diversification and access to liquidity.

    If you’re wanting to look at the investment options available to you, we have an experienced team of advisers who can help you create an appropriate strategy for your situation.

    Investing with Fisher Funds

    If you have any questions about our investment processes or wish to find out more about managed funds please get in touch on 0508 FISHER (0508 347 437) or via email. We also have a handy online Investor Profile Questionnaire that will allow you to find an investment strategy that works for you.

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