Friday Q & A – Paying down mortgage vs investing
I own my home and have money in my offset account, should I keep it there or should I invest?
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 you’re earning over $90k, your marginal tax rate is 39% 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.
Although I believe paying down your offset account is an appropriate strategy for many people, historically investment returns in the share market and property markets have been greater than the cost to borrow (interest rate) over the long-term so it may be a worthwhile strategy.
If you borrow for investment purposes and have debt against your home, it’s best to maximise the debt against your investment (as is tax deductible) and minimise the debt against your home. This can further be done by making interest-only repayments on the investment loan although weigh up the benefits if this results in 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).