Friday Q & A – Paying down mortgage vs investing

Feb 22, 2019

3 min read

Updated: 11 hours ago

Originally written in 2019. Some rules, rates and figures have changed since, so check the current details before relying on them.

Question

I own my home and have money in my offset account, should I keep it there or should I invest?

Answer

This is one of the most common questions people have and the answer depends on a couple of things such as: your risk profile (influenced by your investment timeline) and your borrowing capacity.

One answer I scream every time I hear it is: No, you shouldn’t. The interest you save by having your money in the offset account is an after-tax, risk-free return e.g. if your marginal tax rate is 39% (including the Medicare levy) and your interest rate is 4%, you’ll need to earn 6.6% before tax to get the same result after tax. This is all correct and you will need to take on risk to earn greater than 6.6% before tax however in most instances this isn’t your only option.

The other option is to utilise your borrowing capacity or by creating borrowing capacity by putting the funds in your offset against the loan (WARNING: consider the implications of doing this, especially if you may one day turn your home into an investment property). By doing this your net debt is exactly the same as if you were to invest the funds in the offset account however you have increased your borrowings that are tax deductible as opposed to borrowings that aren’t tax deductible.

Why is this advantageous? The interest on the additional amount you borrowed for investment purposes is tax deductible so if you earn an investment return of 5% and have an interest rate of 4% you will only pay tax on the 1% difference. This changes the equation to: if your return is greater than your interest rate, you will be better off.

Keeping money in the offset suits plenty of people. On the other side, historically investment returns in the share and property markets have been greater than the cost to borrow over the long term, which is why some people borrow to invest instead. It comes with more risk, including the risk that returns fall short of the interest rate.

Additional tips:

If you borrow for investment purposes and have debt against your home, the tax rules favour having more of your debt against the investment (as that interest is deductible) and less against your home. Interest-only repayments on the investment loan can help with this, although that can come with a higher interest rate.
I won’t cover in this post however this strategy is a component of a “debt recycling” strategy which is a long-term strategy to turn your non-deductible debt (bad) into deductible debt (good).

For a real-world discussion, see the r/AusHENRY debt recycling AMA and the r/AusPropertyChat AMA on loan structuring, where Kyle Frost answered questions from Australian homeowners.

I cover this in more detail in my video, Should You Pay Off Your Mortgage or Invest? (A Historical Backtest), on the Edvest YouTube channel.

Explore free Australian finance education from Kyle Frost at Edvest, including the Edvest debt recycling course.

Friday Q & A – Paying down mortgage vs investing

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