Should you invest in the share market before paying off the mortgage?
It's a common problem that many potential investors face. It's common for those in their twenties or (far more likely these days) thirties to start thinking about investing or even retirement soon after buying their first house. Nothing focuses the mind on getting old more than owning your own home, after all.
But it's also likely that many people will tell you that paying off the mortgage should be your number one priority over buying shares, as your house is your 'biggest investment'. Whilst I disagree that your own house even qualifies as an investment, there is merit to this idea. But I also think that anyone tossing up between the two should consider all of the facts.
Paying off your mortgage early is a great use of your money, no denying it. Say your Commonwealth Bank of Australia (ASX: CBA)-issued principle-and-interest home loan is set at an interest rate of 3%. Each additional dollar you put into your mortgage (or offset account) earns you a 3% rate of return (as it's money you won't have to pay 3% interest on).
But here's the kicker. A simple, market-tracking index fund like the SPDR S&P/ASX 200 Fund (ASX: STW) – which basically just invests in the whole Aussie share market – has delivered an average return of 8.18% per annum since 2001. That's a whole 5% more than what paying off your mortgage early can give you. And that's through the tech wreck, the GFC and the Euro debt crises to boot.
On paper, these raw numbers indicate you would be a lot better off if you paid your minimum mortgage payments every week or month and put the rest into Aussie shares.
But of course, there are other factors to consider. Paying off your mortgage early means you own your own home sooner – and benefit from the increased financial security that brings.
Another caveat to consider is interest rates. Rates aren't likely to stay at their current record lows for the duration of a 20- or 30-year loan and could well rise substantially in the future. Therefore, to avoid this interest rate risk it is arguably prudent to funnel extra cash into the mortgage.
Foolish takeaway
Both paying off your mortgage and investing in ASX shares are fantastic ways to spend your money. I think weighing up your individual circumstances, priorities and goals should determine which path you take.
