Should you pay down your mortgage or invest?
What a year it's been for anyone with a mortgage! In just seven months, the cash rate has dropped by 0.75%.
As a result, variable loan rates have fallen from about 6.30% to 5.55%. A homeowner with a $600,000 loan and 25 years remaining would have seen their minimum monthly repayments drop by $275 to $3,720 after the three rate cuts since February.
In most cases, you'll need to let your lender know you'd like to reduce your repayments following rate cuts.
But if you do nothing and leave repayments at their pre-rate cut level, you'll be making substantial extra payments to pay off your loan sooner.
That's certainly the approach plenty of homeowners are taking. Commonwealth Bank figures show only 10% of eligible home loan customers chose to reduce their mortgage repayments following the May interest rate cut.
But how does this strategy compare to investing in the share market?
What's your sweet spot?
Rate cuts are always welcome news. But when rates head south, the savings generated by extra loan repayments start to shrink.
On the flipside, share markets are surging. Aussie shares, for example, have gained 10.9% in the 12 months to the end of August. Add in dividends, and the one-year returns are 14.7%.
The question is: could you make more money investing the cash freed up by lower home loan repayments, rather than using it to pay down your loan sooner?
It's a question that can be answered - but the answer is nuanced.
Your home is a risk-free, tax-free asset. By paying down your mortgage sooner - assuming the average loan rate of 5.55% mentioned earlier - you're effectively earning a tax-free return of 5.55%.
Investment returns, on the other hand, are generally taxable. How much you pay depends on your marginal tax rate, and capital gains tax may apply when you sell. That said, there can be offsets - such as franking credits on some Australian share dividends, or a capital gains tax discount if you've held assets for more than 12 months. Unlike paying down your mortgage, though, investing isn't risk-free - returns can fluctuate and there's always the chance of losing money.
That's why there's no one-size-fits-all answer. Even so, it's useful to know the returns you'd need - for your tax bracket - to be better off investing rather than paying more off your mortgage.
We've crunched the numbers to give you a rough idea, but kept things simple. We haven't factored in franking credits, capital gains tax or other complexities. Every financial situation is unique, and tax law is complex, so it's always best to seek advice from a professional accountant or financial adviser.
For some, the numbers might show one path, but the peace of mind that comes from paying off a home loan and being debt-free can be more valuable than any potential financial gain. The best financial decision is always the one that works for you.
Let's take a look at the numbers for different tax brackets based on the 5.55% home loan rate mentioned earlier. If rates fall further, the investment return you'd need to beat your mortgage will also fall - which could make the case for investing stronger than simply adding extra to your loan.
How much you need to earn on investments to outperform your home loan, based on a rate of 5.55%
|
Taxable income (2025-26) |
Marginal tax rate |
Effective tax rate (incl. 2% levy) |
Required pre-tax return |
|
$18,201 - $45,000 |
16% |
18% |
6.77% |
|
$45,001 - $135,000 |
30% |
32% |
8.16% |
|
$135,001 - $190,000 |
37% |
39% |
9.10% |
|
$190,001 |
45% |
47% |
10.47% |
If your marginal tax rate is 16%
If you earn between $18,201 and $45,000 a year, your marginal tax rate is 16% plus the 2% Medicare levy, giving you an effective rate of 18%.
That means you keep 82% of your investment returns after tax. To get ahead of a 5.55% home loan, you'd need to earn about 6.8% pre-tax.
To give you an idea, Australian shares delivered a return of 12.0% p.a. over five years until the end of June 2025, according to Vanguard. This equates to about 9.8% after tax - comfortably ahead of the loan. Even over 20 years, the 8.0% long-term return translates to 6.6% after tax, still edging out the mortgage.
International shares look even stronger, with 15.8% over five years and 9.3% over 20, delivering after-tax returns of 12.9% and 7.6% respectively - both well above the loan.
If your marginal tax rate is 30%
At the next bracket, covering incomes of $45,001 to $135,000, the marginal rate is 30% plus the 2% Medicare levy, lifting the effective tax rate to 32%. In practice, that leaves you holding on to 68% of your returns after tax.
Here, the benchmark return is 8.16% pre-tax to beat a 5.55% mortgage.
The 12.0% annual return of Australian shares over five years would give you an after-tax return of about 8.2%, so you'd be better off investing your extra money rather than adding it to your mortgage.
Over 20 years, though, Australian shares returned 8.0%, which drops to 5.4% after tax, giving the home loan the edge.
The results are more compelling for international shares, with 15.8% over five years and 9.3% over 20, translating to 10.7% and 6.3% after tax - both comfortably beating the mortgage.
If your marginal tax rate is 37%
For those earning $135,001 to $190,000, the marginal tax rate climbs to 37%, and with the Medicare levy the effective rate is 39%. That means you're left with just 61% of your investment gains.
You'd need to earn about 9.1% pre-tax to get ahead of a 5.55% home loan. Over five years to June 2025, Australian shares returned 12.0% p.a., which drops to about 7.3% after tax - more than enough to beat the loan. Over 20 years, the 8.0% return falls to just 4.9% after tax, leaving the mortgage ahead.
International shares tell a stronger story: 15.8% over five years and 9.3% over 20 convert to 9.6% and 5.7% after tax - both edging out the home loan.
If your marginal tax rate is 45%
At the top end of the tax scale, if you earn over $190,000 annually, your marginal tax rate is 45% plus the 2% Medicare levy, bringing your effective rate to 47%. That leaves you with only 53% of your investment returns after tax.
Such a significant tax take means that, in theory at least, investors really need to look at investments offering high returns in order to pocket worthwhile after-tax gains. More so relative to the savings of paying down a home loan sooner.
To outperform a 5.55% home loan, you'd need to earn at least 10.47% pre-tax. Australian shares returned 12.0% p.a. over five years to June 2025, but after tax this shrinks to about 6.4% - but that's still ahead of the mortgage. Over 20 years, the 8.0% return drops to just 4.2% after tax, so the mortgage is the better option here.
International shares, at 15.8% p.a. over five years and 9.3% p.a. over 20, translate to after-tax returns of 8.4% and 4.9% respectively.
The bottom line
It's one thing to crunch the numbers on paper. It's another to declare the 'best' strategy for investors based on their tax rate.
That's because investing involves risk. Yes, risk can be managed by maintaining a diversified portfolio and taking a long-term approach.
But even very high-income earners may not feel comfortable about investing in higher risk/higher return assets like shares.
By contrast, the savings on your home loan are a sure thing. Using the savings of lower rates to pay down your loan sooner is a low risk, low effort strategy that can deliver benefits regardless of your tax rate.
What matters is that you find the sweet spot that works for you - deciding whether you'd prefer to take advantage of cash savings to grow a portfolio of investments, or become mortgage-free sooner and save a bundle in loan interest along the way.
Frequently Asked Questions about this Article…
Recent interest rate cuts have lowered variable loan rates from about 6.30% to 5.55%, which means if you have a $600,000 loan with 25 years remaining, your minimum monthly repayments could drop by $275 to $3,720. However, you need to inform your lender if you wish to reduce your repayments.
Paying down your mortgage offers a risk-free, tax-free return equivalent to your loan interest rate, which is currently 5.55%. This approach provides peace of mind and the certainty of becoming debt-free sooner, saving on loan interest over time.
If you keep your mortgage repayments the same after a rate cut, you'll be making extra payments towards your loan, which can help you pay it off sooner. This is a strategy many homeowners are adopting, as it can lead to significant savings in interest over time.
Recent interest rate cuts have reduced variable loan rates from 6.30% to 5.55%, lowering monthly repayments. For a $600,000 loan, this means a reduction of $275 in monthly payments. However, you need to inform your lender if you wish to reduce your repayments.
Deciding whether to invest or pay down your mortgage depends on your financial situation and goals. Paying down your mortgage offers a risk-free, tax-free return equivalent to your loan rate, while investing can potentially offer higher returns but comes with risks and tax implications.
The decision depends on your financial situation and risk tolerance. Investing can offer higher returns, especially with current share market gains, but it involves risk and potential tax implications. Paying down your mortgage is risk-free and offers a guaranteed return equivalent to your loan rate.
To outperform a 5.55% mortgage, the required pre-tax return varies by tax bracket. For example, if your marginal tax rate is 16%, you'd need about a 6.8% pre-tax return. Higher tax brackets require higher returns to beat the mortgage rate.
To outperform a 5.55% mortgage, your required pre-tax return varies by tax bracket. For example, if your marginal tax rate is 16%, you need a 6.77% return. Higher tax brackets require higher returns, up to 10.47% for the highest bracket.
Your marginal tax rate affects the after-tax return on investments. Higher tax rates mean you keep less of your investment returns, making it harder to outperform the guaranteed savings from paying down your mortgage.
Tax rates affect the net return on investments. Higher tax rates mean you keep less of your investment gains, making it harder to outperform the guaranteed return of paying down a mortgage. It's important to consider your effective tax rate when making this decision.
Australian shares have historically delivered strong returns, with a 12.0% annual return over five years. Depending on your tax rate, this could outperform a 5.55% mortgage, but it's important to consider the risks and tax implications of investing.
Investing involves market risk, meaning returns can fluctuate and there's a chance of losing money. Unlike the certainty of mortgage savings, investment returns are not guaranteed and are subject to taxation.
Investing involves risks such as market fluctuations and the potential for loss, whereas paying down your mortgage is a low-risk strategy with guaranteed savings. It's important to weigh these factors based on your financial goals and risk tolerance.
International shares have shown stronger returns compared to Australian shares. Over five years, international shares returned 15.8% annually, translating to a 12.9% after-tax return for lower tax brackets, which is higher than the returns from Australian shares.
The best decision depends on your personal financial situation, risk tolerance, and long-term goals. Consider consulting a financial adviser to explore your options and find the strategy that aligns with your objectives, whether it's growing investments or becoming mortgage-free sooner.
Every financial situation is unique, and tax laws are complex. Professional advice can help tailor a strategy that aligns with your financial goals, risk tolerance, and tax situation, ensuring you make the best decision for your circumstances.
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