Should I Invest or Pay Off My Mortgage?

As Certified Financial Planners ®, we are often asked the question, “Should I invest or pay off my mortgage?”

The answer depends on various factors, such as how much equity you’ve got and your cash flow.

In our video below, we explain some basic investing principles for people who’ve got a mortgage and enough cash flow to invest as well.

But before we discuss the topic further, we’re going to explain the difference between deductible debt and non-deductible debt briefly. Watch the short video here:

DISCLAIMER – The information provided in this blog is general and does not consider your individual financial needs or objectives. It does not constitute personal advice. We recommend seeking out professional and independent financial, legal and tax advice which has been designed for your individual situation before acting on any information contained below.

Deductible Vs Non-deductible Debt

Simply put, a deductible debt is one for which you can claim a tax deduction for the interest you pay on the loan. Whereas non-deductible debt means you cannot claim any tax deductions on the loan.

Your mortgage for your primary residence is a non-deductible debt; however, if you’ve got a loan for an investment property, the interest you pay is a tax deduction.

Other non-deductible debts in Australia include personal loans and car loans if the loan proceeds haven’t been used to purchase an investment to produce taxable income or assist you in working to produce taxable income.

Another example of a deductible debt is an investment loan where you are using the funds to purchase assets that will produce an income.

Should I Invest or Pay Off My Mortgage?

It’s important to note that if you’ve recently acquired a mortgage or have a lot of debt, and your cash flow is very tight, investing probably isn’t right for you at this stage of your life.

On the other hand, people who’ve got a lot of equity and a good cash flow with surplus cash but still have a mortgage are better positioned to invest.

We are often approached by people who’ve got a surplus amount to invest but don’t know what to do with the money. The basic principle we like to tell people in this position is that it doesn’t make sense for you to invest your cash into an investment when you have a non-deductible home loan.

Here is an example of what we mean:

Person X has $100,000 left on their non-deductible home loan and received an inheritance of $100,000. This person is not sure whether to invest the money or pay off their mortgage.

In this scenario, we would suggest using their inheritance amount to pay off their home loan (the non-deductible debt).

Then if they re-borrow and get an investment loan of $100,000 and invest that amount, they would end up in the same position – as they’ve got their $100,000 investment and they’ve still got $100,000 in debt.  However, their debt has been converted from a non-tax-deductible home loan to a tax-deductible investment loan.

Paying Down Non-Deductible Debts First

We believe this principle discussed above is true for every dollar that’s yours.

So, if you’ve got, for example, a surplus cash flow of $1,000 a month and you think you’d like to invest that money elsewhere and not pay off your home loan, what we would say is that’s not the most tax-effective way for you to invest.

You’re much better off directing that $1,000 to your non-deductible home loan every month and going and getting another investment loan and drawing down from that investment loan $1,000 a month.

This is because it gives you the same result in terms of assets and debt, but you’re paying down your non-deductible debt while increasing your tax-deductible debt. It’s just a more tax-effective way to invest your cash.

And when you’re investing in a situation like this, what sort of investment can it be? Well, it can be a deposit for an investment property or a share portfolio, but what it shouldn’t be is any sort of defensive asset class. That’s because you’re not going to borrow money to invest in a term deposit or borrow to invest in fixed interest and bonds. Likewise, you wouldn’t invest surplus cash flow into a term deposit or bonds while you have a mortgage, you would just pay down your mortgage quicker.

We recommend:

• Treating your home loan as the defensive part of your portfolio
• Invest using borrowed funds, and
• Invest in a 100% growth asset portfolio (only up to an amount that’s appropriate for you and your tolerance to risk)

Personalised Investment Advice for Brisbane Residents

If you are looking for an experienced financial planner to offer tailored investment advice and assistance, get in touch with Precision Wealth Management today.