RateCity.com.au
  1. Home
  2. Home Loans
  3. Articles
  4. The pros and cons of paying off your mortgage early vs buying an investment property

The pros and cons of paying off your mortgage early vs buying an investment property

Mark Bristow avatar
Mark Bristow
- 6 min read
The pros and cons of paying off your mortgage early vs buying an investment property

Paying off your mortgage early lets you own your home sooner and save money on interest charges. But is it the best option for you when it comes to wealth creation? There is no one-size-fits-all approach that is right for everybody.

Paying off your mortgage is rarely a bad idea, but you may also have the option to invest in a rental property. Putting extra money into your home loan can reduce the amount you pay in interest and help build equity in your home faster, but buying an investment property could potentially help you generate more wealth and build a second income stream.

However, there are also risks involved in borrowing more money to purchase a second property. You could risk losing both houses if you default on your mortgage, so it’s important to make an informed decision.

There are some obvious financial and emotional benefits to paying off your mortgage early, such as owning your property outright without a mortgage hanging over your head. Once your house is mortgage-free, you no longer have to worry about spending your hard-earned cash on monthly repayments and interest charges. 

Making extra repayments to pay off your mortgage faster can lead to significant interest savings over the long term. For example, imagine you have a $350,000 mortgage for 25 years at a 6.92% interest rate. Using a mortgage repayment calculator to find the monthly principal and interest repayments, the loan will cost you approximately an additional $386,768 in interest charges over the full term.

However, if you decide to pay an extra $250 into your home loan each month, your debt will end five years and one month earlier. Plus, you’d pay $92,029 less in interest. Keep in mind that this example doesn’t include fees and charges, and assumes the interest rate will remain the same over the full loan term.

While paying off your debt early can help boost your savings by reducing the amount of interest you pay on your home loan, it might not be the most financially savvy decision for everyone. For instance, people with multiple debts often prioritise paying off loans with higher interest rates first, as this can help to save on interest in the long run. As home loans tend to have lower interest rates compared to some other types of loans, it might be worth targeting other forms of debt before eliminating your mortgage debt. 

Your decision may also depend on how far along you are on your home loan journey. Paying extra into your home loan is often more beneficial early in the loan term due to compounding interest. Extra repayments at the beginning of a 30-year term can be much more effective in cutting down the total interest you’ll pay on the loan than extra repayments made 15-20 years into the loan.

Putting more money towards paying off a mortgage also helps you build equity in your home. Some people may choose to keep their mortgage running to use the redraw facility or to access a home equity loan if required. For example, while you cannot sell a portion of your property to meet an emergency expense, you might be able to redraw some of the additional funds you've paid into the loan to meet your needs. However, keeping your mortgage open after retirement may be challenging in the absence of a steady source of income to meet the repayments.

The pros and cons of buying an investment property

It's possible to use the equity in your home to pay the deposit on a second property to grow your investment portfolio. Buying an investment property could help you earn rental income while minimising the impact on your cash flow, as interest payments on an investment loan are tax-deductible. You may also see a capital gain from the eventual sale of the property. 

However, there's no guarantee that the property you buy will always increase in value. It's worth researching your options and buying a property in a good location. You can order a free property report to get historical data and trends regarding property prices, rental and vacancy rates in the area.

It’s also worth noting that taking out another mortgage for a second property means increasing your debt substantially. It’s important to check whether you have adequate cash flow to simultaneously manage the repayments on two mortgages.

While crunching the numbers, consider how you’re going to cover the repayments for vacant periods when there is no rental income. You’ll also require money for property maintenance, but you might be able to claim some of these expenses on your tax return.

Should I buy an investment property or pay off my mortgage early?

If you're considering whether to buy an investment property or pay off your mortgage early, you'll need to consider the size of your mortgage first. If you owe more than 80% of your home's current value, you'll find it difficult to refinance your home loan and use your equity to fund the deposit for a second home. Instead, you could think about paying down your home loan and building your equity to increase your ownership of the house.  

On the other hand, if you've got enough equity in your home, using it to purchase an investment property could potentially help you generate more wealth. However, it remains a risky option, and it’s advisable to speak with a mortgage broker or a financial advisor to ascertain whether you can afford to pay two mortgages in the long run.

If you take out an investment loan for the second property, it might be interest-only for the first few years. However, your mortgage repayments may jump significantly after the interest-only period is over.

You also need to pay for property maintenance and other small expenses to make your rental property tenant-worthy. Even though the interest you pay on an investment loan is tax-deductible, you'll still need adequate cash flow to cover various additional expenses, including insurance and property management fees.

The best choice between buying an investment property or paying off your mortgage faster will depend on your financial situation and long-term goals. It's also worth considering other investment options, such as building your super to contribute towards a more comfortable retirement, or diversifying your portfolio to build more wealth.

Compare home loans in Australia

Product database updated 16 Jun, 2024

This article was reviewed by Personal Finance Editor Alex Ritchie before it was published as part of RateCity's Fact Check process.