Paying down debt vs investing - which strategy is better?

If you’re like most Kiwis you want to grow your wealth for your retirement, but you’ve also got a hefty mortgage.

So what’s the best way to improve your financial position? Pay off your mortgage as fast as possible or buy an investment property?

In this article you’re going to get an honest comparison of these two options. That way you can decide which is best for your situation.

If you have any questions or thoughts, please share them in the comments section below.

Shouldn’t I pay off my mortgage before I invest in property?

Being mortgage-free can become somewhat of an obsession for many Kiwis.

That could be because your parents drilled into you that: “Unless you have paid off your mortgage in full, the bank owns it – not you.”

And that’s the reason some Kiwis think they need to pay off their mortgage first before they purchase an investment property.

After all, the default term for a mortgage in New Zealand is 30 years. And the national average age of a first home buyer in this country is 35 years old, according to CoreLogic.

So, a person in this position would naturally think: “Oh, I’m going to be 65 before I’m mortgage-free. I want to pay this off before I take on more debt.”

While it’s normal to feel this way, this point of view is based more on emotion than evidence. That’s not to say everyone should invest rather than tackling the mortgage.

But it may surprise you to learn most first-time property investors we work with here at Opes Partners still have a sizeable personal mortgage.

And some of those who are already mortgage-free end up saying: “I wish I’d started investing sooner.”

Is there really a trade-off? is it one or the other?

When buying an investment property many investors will borrow all of the money to purchase the rental.

They do this by borrowing the deposit against the equity they already have in their own house.

So it’s not a question of: “I’ve got a lump of cash, should I use it to pay off mortgage or use it as the deposit for an investment property?”

That’s not where the trade-off is. Instead, it’s more around the cashflow of the property.

At current interest rates many properties are negatively geared – the rental income doesn’t cover all the costs.

So, the investor has to top up the property with some of their own cash, for instance by $150 a week.

And the natural question becomes: “OK, will I get a better return investing this $150 in my own mortgage, or by using it for an investment property?” Let’s look at the numbers.

It should be pointed out there are also other ways you can invest this money, for instance shares, managed funds and term deposits.

Show me the comparison … what would happen if I redirected some of my mortgage repayments to an investment property?

Let’s see how your would-be assets play out if you allocated some of your mortgage towards another investment property, rather than paying down your mortgage as fast as possible.

Let’s say you have a $600,000 mortgage on your own home. Your minimum repayment is about $700 a week (assuming a 4.5% interest rate).

But, let’s say you have an extra $150 a week. Let’s look at the two scenarios.

Scenario #1: You use your $150 to pay down your mortgage more quickly; that shaves 9 years off your mortgage.

And over the first 15 years you would have paid off an additional $165,322 of your mortgage, compared with just making minimum repayments.

Let’s see what the alternative is.

Scenario #2: In this scenario you leave your mortgage on a 30-year loan term, and instead allocate some of that money to paying the “top up” of an investment property.

Let’s call it a $620,000 Christchurch townhouse, which you assume will increase in value by 5% a year.

After 15 years, your $150 a week returns $668,935.

So investing in property is forecast to return 4x as much as paying down your mortgage.

So, the numbers on their own appear to suggest property generates a higher return. But that doesn’t mean investing in property is always the right answer for you. We'll explore this below.

But, if you want to play around with the numbers yourself, use our Pay Down Debt vs Invest calculator

When is the right time to pay off my mortgage?

In the above scenarios the numbers have shown property gives a higher return.

But this is on the basis of the property in question growing in value by an average of 5% over a 15-year period.

However, growth in the value of the property market is not guaranteed. There’s no guarantee that topping the property by $150 a week will result in almost $669k worth of capital gains.

Yes, the property has grown by over 5% per year over the last 20+ years (on average), but there’s no guarantee it will continue.

However, if you pay $150 off your mortgage, then your equity position has definitely improved.

So, while investing in property might generally provide a higher return … paying down your mortgage provides a more certain return.

And there are some instances where paying off your mortgage might be a better financial decision, rather than investing in property.

#1 If you’re not in a position to buy an investment property:

It’s all very well telling you to just go and buy an investment property, but what if you can’t get the money from the bank?

What if you don’t have enough equity in your house to get a 100% investment mortgage?

In these scenarios you can’t invest in property (at least not yet), so putting your money into paying down your mortgage may be a better idea.

This will also help you get into a better financial position, which will help you get closer to being ready to invest.

#2 If you’re close to retirement:

Similarly, if you’re close to retirement (say 5 years away) and you still have a mortgage, paying it off may be the right call.

That’s because you might decide you can’t live the lifestyle you want in retirement if you’re still making regular repayments to the bank.

When is the right time to invest in property?

As mentioned above, while paying down your mortgage tends to provide a more certain return, property tends to provide a higher return. It’s the old risk v reward trade-off.

Typically, the sort of people who will invest in property need to build their wealth – especially outside their own home.

The trouble with solely paying off your mortgage for your retirement is … you can’t eat your house.

Sure, you might have a lot of equity in your house. But, if part of your retirement is to remain living in your family home, you may be equity rich but cash poor.

That’s where you will likely want other assets (other than your main home) to live off.

So the sort of people who will invest in property will own their own home already (but not always), are aged 30-55 (as a ballpark), and need to grow their wealth to sort out their financial future.

These people will be investing in the property market long enough to ride out any ups and downs in house prices.

And even if the property market appreciates at a fraction of what it has in the past, these sorts of investors will tend to do well.

I don’t have spare weekly income to buy an investment property?

The majority of New Zealanders are already ahead of where they need to be on their mortgage … especially those who have had it for a while.

In fact, 68% of borrowers have paid off more than the minimum required, according to Westpac.

This happens because many people increase their mortgage repayments as their salary goes up, which means they are paying more than they “need” to.

This is something our property partners, here at Opes, often find when they sit down with investors.

For example, some investors are paying $200 a week more than they need to. This means you may have access to extra cash you just don’t know about.

So, what could the options be for this extra money? Yes, you could continue to pay down your mortgage. This will be the preferred option for people who aren’t in a position to invest, or for older Kiwis who are closer to retirement.

However, another option could be to allocate some of that money towards another investment property.