Should you pay off your mortgage early or invest?
Every day I meet people whose sole financial goal is to pay off their home as quickly as possible, believing that once they do, they'll be financially free.
The problem is that your home is an asset, not an investment. You can't 'eat your home'. Unless you're willing to downsize, relocate to a cheaper area or bring in a boarder, your home won't generate income or give you capital back.
It's important to understand that if you only concentrate on paying off your mortgage, to the exclusion of investing, there's an opportunity cost that can rob you of choice.
Which means, yes, paying extra on your mortgage might be a smart thing - as long as you're also investing.
I've run so many case studies on this, and the maths on paying off your home and then investing doesn't add up like you might think it would. Let me explain with an example.
Let's assume you bought a house for $950,000 with a 20% deposit, leaving a $760,000 mortgage. You've decided you want to pay that loan off 10 years earlier, which means you have to add an extra $888 per month to your repayments. The result? In 20 years' time, you'll be mortgage free.
But what if you took a different approach? What if you use some of that $888 to pay a little extra off the mortgage each month and invest the rest?
Yes, you would still have a mortgage at the end of 20 years, but you would also have an investment portfolio that would be higher than your mortgage balance. I've run the example in the table below.
The example assumes a mortgage taken over 30 years with an interest rate of 6%, average investment growth of 8.5% (Australian shares returned around 9.3% a year over 30 years according to Vanguard's Index Chart) and property growth of 6.4% (as reported by CoreLogic, now Cotality).
|
Person 1: Pay off mortgage early and then invest |
Person 2: Pay a little extra onto mortgage and invest |
|
|
Buy home (with 20% deposit) |
$950,000 |
$950,000 |
|
Mortgage |
$760,000 |
$760,000 |
|
Repayment (monthly) |
$4,557 |
$4,557 |
|
Extra repayments (monthly) |
$888 |
$500 |
|
Investment amount (monthly) |
$0 |
$388 |
|
Period of time before mortgage paid off |
20 years |
23 years and 4 months |
|
Balance of mortgage after 20 years |
$0 |
$179,406 |
|
Investment value in 20 years |
$0 |
$243,276 |
|
Home value in 20 years |
$3,405,206 |
$3,405,206 |
|
Extra net $ |
$0 |
$63,870 |
After 20 years, person 2 is already more than $60,000 ahead. But let's see what it would look like if, after paying off the mortgage, person 1 started investing their entire mortgage repayments and the spare $888 - $5,445 each month in total - up to the point that person 2 is also mortgage free.
|
Person 1: Pay off mortgage early and then invest |
Person 2: Pay a little extra onto mortgage and invest |
|
|
Balance of mortgage after 23 years and 4 months |
$0 |
$0 |
|
Investment amount (monthly) |
$4,557 $888 = $5,445 |
$388 |
|
Investment value in 3 years and 4 months |
$254,191 |
$349,406 |
|
Extra net $ |
$95,215 |
Even when person 1 is putting so much more into investing, they're still over $95,000 behind person 2, who is now also mortgage free - and has more choice.
You might immediately think, who has an extra $888 per month? Or what am I investing in? Those are valid questions. But for now, I just want to start challenging you on some firmly entrenched beliefs many of you have when it comes to debt - that being debt-free is the only sensible option available to you.
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This is an edited extract from Dare to be Wealthy (Allen & Unwin, $34.99), republished with permission.
Frequently Asked Questions about this Article…
The article argues there’s no one-size-fits-all answer: your home is an asset (not an income-producing investment), so paying off the mortgage early can feel safe, but it also creates an opportunity cost. The case study shows that splitting extra cash between reducing mortgage and investing can leave you better off financially and give you more choice than focusing only on becoming debt-free.
Using the article’s example, putting $888 extra per month entirely toward the mortgage made Person 1 mortgage-free in 20 years but left them with no investments. Person 2 added $500 extra to the mortgage and invested $388 monthly instead. After 20 years Person 2 still had a $179,406 mortgage balance but a $243,276 investment portfolio — about $63,870 net ahead. Even after Person 1 later invested large sums, they remained roughly $95,000 behind Person 2.
The case study assumptions: house price $950,000 with a 20% deposit (so a $760,000 mortgage), a 30-year loan with a 6% mortgage interest rate, average investment growth assumed at 8.5% (the article notes Australian shares returned about 9.3% per year over 30 years per Vanguard), and property growth of 6.4% (per CoreLogic/Cotality). The standard monthly repayment shown was $4,557 and the extra payment considered was $888 per month.
The article explains that a home doesn’t normally generate income you can live on — you can’t ‘eat your home’ unless you sell, downsize, relocate to a cheaper area or take on a boarder. Because it doesn’t produce cash flow by itself, treating your home as the only ‘investment’ can limit choices and incur opportunity cost compared with building an income-generating investment portfolio.
Opportunity cost here means the returns you forgo by directing extra money to your mortgage instead of investing it. The article’s example shows that investing some of that extra cash while still paying down the mortgage can produce a larger net financial position and more options down the track than paying the mortgage off as quickly as possible.
Yes — the article says making extra mortgage repayments can be smart, but ideally you should combine extra repayments with regular investing. That balance can reduce debt while still capturing potential higher investment returns, improving your overall financial outcome and flexibility.
The author used an assumed average investment growth of 8.5% for the case study and referenced Vanguard’s chart showing Australian shares returned about 9.3% a year over 30 years. For property growth the article cited CoreLogic (now Cotality) at about 6.4%.
In the example, paying the mortgage off 10 years earlier required an extra $888 per month on top of the base monthly repayment of $4,557, which would make the mortgage paid off in 20 years instead of 30.
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