Throughout the COVID-19 pandemic, Australians have saved at record levels. Newly-released Treasury data shows households and businesses have amassed an impressive $200bn in savings.
It’s with the hope that these savings will drive recovery following the pandemic, but what if you could increase these savings by paying off your mortgage faster? Should you increase home loan repayments, save in interest and help get rid of debt sooner, or will investing in shares offer better value? Here is a fresh look at the best bang for your buck, both short and long-term.
Paying off your mortgage faster
For many Australians, a home loan is the biggest debt they will ever have. Paying off your home loan early can save you money and take a financial load off your shoulders.
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One of the biggest considerations to take into account when deciding whether or not to put your extra money into your mortgage payments is how much you will pay in interest over the amortization period (the total amount of time it will take to pay off the loan). In order to have an estimate, you need to understand that your repayments cover two parts: the principal and the interest.
When you make extra monthly repayments or lump sum payments, you reduce the amount of your principal. This, in turn, shortens the length of time it takes to pay off the loan. The less time it takes to pay off the loan, the less you will pay in interest overall.
Generally speaking, it’s more economical to reduce your mortgage interest than it is to earn interest on your bank savings. Because interest rates are so low now, your extra repayments are going in to pay off the straight principal. Reducing your loan now also reduces your exposure risk to large rate increases in the future.
Low-interest rates, while good for your home loan, is not always great when it comes to saving your money. Saving your money in the bank (even one with a high-interest rate), doesn’t allow your money to grow quickly.
Investing the money you’ve saved during the pandemic into shares may mean you don’t have to contribute much to see high returns. If you have a long time until you need to meet your financial goal, your returns will compound. What this means is that in addition to a higher rate of return on investments, your investment earnings will also earn money over time.
Higher returns, greater risk
When comparing the two financial options you won’t be surprised to learn that with higher returns comes greater risk. Investing in shares is a risky endeavor, particularly if you try to time the market rather than invest over time. Moneysmart suggests that people only invest in shares if they have an investment timeframe of more than five years. Short-term returns tend to be more volatile.
Basically, it all comes down to interest rates. If shares are delivering higher annualized returns than your lender is charging you in interest, then it makes sense to invest in shares. Amidst a pandemic, however, you must be prepared for a roller coaster of a journey. The stock market can quickly go from all-time highs to all-time lows, which is why you need to look at investing as a long-term approach. With patience, the returns can be great.
Using your savings for both
Like all financial decisions, the right option for you depends on your goals, risk appetite, and investment timeframe. If this can fluctuate, don’t forget there’s room to both pay more on your mortgage and invest in shares.
You could look to invest in high-yielding shares — either through a lump sum or monthly contributions — and then use the dividends to pay off your mortgage. Another option would be to focus on paying off the mortgage in the first instance so that you can draw down equity and free yourself to invest in shares down the track.
With the right strategy, juggling both can help you pay down ‘bad debt’ and pick up ‘good debt’. Lower tax on your investments can also help you to reach your financial goals sooner. That said, don’t make the decision based on tax benefits alone.
Your bigger picture of wealth
There are many options to turn your current savings into a bigger picture of wealth. Investing in your mortgage can liberate your lifestyle by reducing one of your biggest financial burdens and can have a huge impact on you and your family’s wellbeing. On the other hand, investing outside of your home loan is worth considering as part of your complete wealth-building strategy.
The important thing to do is to do your own research. This way you can make informed decisions and ensure you don’t miss out on the opportunities that come when you have extra cash in the bank. Let’s try to take something positive out of this pandemic.