To the relief of mortgageees across the country, last week the Reserve Bank of Australia (RBA) announced its second interest rate cut of 2025 (and of the last four years). The 25-basis point reduction brings the cash rate down to 3.85%.
The most obvious effect of this cut is a reduction in the level of interest that people holding mortgages or other variable loans are required to repay.
Many Australians are well-versed in holding loans over property. As such, they may have a significant level of cash held in offset accounts against their mortgages. However, with this latest interest rate cut, the benefit of doing this has just decreased, alongside those repayments.
So today, let's discuss the benefits of paying down a mortgage instead of investing that money into the stock market and ASX 200 shares.
Rate cuts and ASX 200 shares
Well, to investigate this question, we first have to establish how paying down one's mortgage earlier than required or holding cash in an offset account benefits an investor.
To be clear, we'll be using the example of someone paying down the mortgage on their own family home, not an investment property. After all, mortgage interest on an investment is already tax-deductible in most cases. Thus, paying it down early doesn't quite get the same bang for one's buck.
As with any investment, it comes down to weighing up the returns on each dollar.
When you repay your mortgage or stash cash in an offset account, you are essentially securing a return of whatever the interest rate on your mortgage is. Let's say your mortgage has an interest rate of 5%. If that is the case, every dollar that you contribute to this mortgage is securing you a 5% return on your invested capital.
Historically, the ASX 200 share market has returned a lot more than 5%.
Take a simple ASX index fund like the SPDR S&P/ASX 200 ETF (ASX: STW). Since its ASX inception in 2001, this exchange-traded fund (ETF) has returned an average of 8% per annum (as of 30 April).
That 8% is made up of 3.36% per annum in share price growth and 4.64% per annum in dividend returns.
Now, returns from index funds are never uniform. Some years, you can expect a fund like this to grow at 10% or even 12% per annum. Others, it might manage 2% or even go backwards. But over long periods of time, these index funds have historically delivered decent returns (8% per annum in this case).
So, done deal right? Unless interest rates rise to 6% or 7%, it's a better idea to invest in the stock market?
More than numbers…
Well, on paper, that is arguably the case. There are other benefits that come with paying down a mortgage or keeping cash in an offset account, though. These might end up tilting your personal calculations.
For one, a paid-off mortgage lifts a significant cloud over one's financial future. Not having to pay the bank every month for the privilege of living in your own home is a highly desirable goal. Forgoing hitting this achievement as early as possible for long-term stock market gains is something that many Australians might not want to trade off, and understandably so. No one should ever be faulted for prioritising the security of the roof over one's head above anything else.
For another, keeping cash in an offset account still gives your capital complete liquidity. If you have a financial emergency, that money is always there, ready to be withdrawn whenever you require it.
The share market does not offer this protection. Share prices move up and down every working day, outside of our control. That means that there is no guarantee you can sell out of your stock market investments at a moment's notice without taking a potential haircut. You also have to pay taxes on any gains you may have made if you sell shares.
All in all, choosing to pay down a mortgage or otherwise invest in ASX 200 shares is a personal choice. Whether you opt to get the best possible returns for your capital or pay off your own home as quickly as possible, there is no wrong choice here.
