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

One of the simplest ways to pay off a mortgage faster is to make extra repayments, which 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 earlier. Plus, you’d pay $92,052 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 them save on interest charges in the long run. As home loans tend to have lower interest rates compared to some other credit products, it might be worth targeting other forms of debt before going after your mortgage. 

Your decision may also be affected by how far along you are on your home loan journey. It can be more beneficial to pay extra into your home loan early in the loan term due to compounding interest. For example, making extra repayments at the beginning of a 30-year term can much more effectively cut down the total interest you’ll pay on the loan than making extra repayments 15-20 years into the loan.

Putting more money towards paying off a mortgage also helps you build equity in your home. Some people who are in a position to pay off their home loan 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 can’t sell a portion of your property to pay for an emergency expense, you might be able to redraw some of the additional repayments you've previously made on the loan. However, keeping your mortgage open after retirement may be challenging without a steady source of income to meet the repayments.

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 benefit from capital gains if you eventually sell the property. 

However, there's no guarantee that the property you buy will always increase in value. To help maximise your chances, it's worth researching your options so you can buy a property in a good location. Consider looking at historical data and trends around property prices, rental and vacancy rates in the area.

Remember that taking out another mortgage for a second property means substantially increasing your debt. It’s important to check whether you will be able to simultaneously manage the repayments on two mortgages.

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

Before deciding whether to buy an investment property or pay off your mortgage early, consider the size of your mortgage. If you owe more than 80% of your home's current value, you may not have enough equity available for a deposit on a second home. Instead, you could think about making extra home loan repayments and building your equity to increase your ownership of the house.  

On the other hand, if you have enough equity available in your home, using it to purchase an investment property could potentially help you generate more wealth. This could still be a financially risky option depending on your financial situation. You may want to speak with a mortgage broker or a financial advisor to work out whether you can afford to pay two mortgages, and whether this strategy will be worth it for you in the long run.

If you take out an investment loan for a second property, the repayments might be interest-only for the first few years. This means that your mortgage repayments may jump significantly after the interest-only period is over and you revert to principal and interest repayments.

As an investor, you’ll also need to pay for property maintenance 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.