When should you pay off the mortgage, and when should you invest?
Over the last few years, this question rolls around frequently on social media.
One view suggests that mortgages should be eliminated ASAP. The benefits include not worrying about interest rates, and the ability to invest larger amounts of money into assets other than your main home sooner.
Investing over mortgage reduction however, assumes currency used to acquire appreciating assets, will always depreciate. Investing before mortgage reduction may allow diversification of wealth beyond just one thing (your home). It may also lead to a faster rate of wealth accumulation over time.
Both views contain some extreme perspectives. So in this article, I’ll show you some pro’s and con’s and also a ‘hybrid’ approach where people can choose to do both.
Firstly, let’s cover off the traditional perspective to this question.
1 – Mortgages are financial death pledges. So you should be rid of it as soon as possible. If your sole expectation with property is to profit instead of create a place of stability for your family, you’re running the risk that rising interest rates will catch you out. Even recently, we’ve been reminded of the risks that over-extending oneself can bring. Levering up when interest rates are low, inevitably creates stress when rates rise. The faster you become secure in your own home and in a position to invest for retirement, the better. This is the way it’s worked in the past, so it’s reasonable to assume the future won’t be all that different.
And now this view…
2 – People are starting to realise the money’s broken. When Nixon took the US dollar [fully] off the gold standard in 1971, the debasement of the worlds reserve currency kicked into high gear. No matter the country, our wealth is being stolen through the dollars we’re forced to use. Each generation’s constantly forced to work harder and harder just to own a home and have a chance at not dying poor. So to fight back, we’re going to leverage off the ‘bug in the system’, and we’re going to borrow depreciating currency to acquire appreciating assets. We believe over the long term interest rates have to go to zero, so we’re going to take advantage of this.
Now, after accounting for your own bias, consider the reasons why paying down your mortgage faster during this time, is a wise move for you.
Advantage 1:
You eliminate the chance of being kicked out of home ownership by the bank.
Advantage 2:
Getting rid of the mortgage means you’re able to start investing larger amounts of money faster.
As we’ve seen since March of 2020, occasionally central banks make policy errors in keeping interest rates too low for too long, which then requires a period of higher interest rates to clean up the mess. If the focus is on aggressive mortgage reduction, you’re reducing the risk you’ll ever be forced into selling your home.
So now consider why you should invest more, over faster mortgage reduction?
Advantage 1:
Instead of concentrating all that money into just one asset (your house), you can build up other investments to fund your retirement, without selling your home.
Advantage 2:
If the property and share markets really are gigantic Ponzi schemes, the rate of capital appreciation will only become stronger when (if) interest rates drop.
For over 50 years now (more or less), with each debt-cycle there is, interest rates hit lower highs, and lower lows. For those on high disposable incomes and a longer timeframe to invest, starting sooner at the expense of aggressive mortgage reduction could be the smartest move. Yes it’s risky, but the best time to engage in risk, is when you don’t have much to lose, and there’s time to recover from mistakes.
You could argue this both ways of course, but here’s how you can adopt both views with your mortgage structure:
A mortgage structured correctly today, can be used as a low-cost ‘reverse-mortgage’ later. This allows you the option of being debt free sooner, with the benefit of accessing this equity again in the future (in retirement).
By using a ‘revolving line of credit’ and then repaying the balance at time of retirement, creates the option of being able to borrow up to the agreed limit at some stage in the future. (This may not work in all circumstances /subject to lending criteria).
So, if you prefer the balanced approach to the question of ‘when to pay off the mortgage, and when to invest’, these ‘synthetic’ reverse-mortgage-like revolving line of credit facilities can be a great middle ground. All it takes is a little forward planning before you start getting aggressive on those mortgage accounts. You avoid the ‘concentration risk’ that comes along with putting all your money against the house, and you get to choose when to invest, and when to repay debt.
Ultimately, the money in your home isn’t really ‘working for you’. It’s saving you an interest rate, and yes, those savings can compound, but it’s a finite return. Investment returns can (in theory) be infinite. True wealth isn’t found in saving, it’s found in building.
And now the disclaimer: Paying off your mortgage faster, or using your money to invest elsewhere, is a complicated area and there’s loads of other risks and benefits you should consider. Avoid risks by taking a long term view on all your money-decisions. Book in a free 15-min discovery call today, even if you’re an existing client, to discuss how we can help.
*This article was published in the NZ Herald on the 14th of April, 2024
