One of the biggest debates in personal finance is whether to pay off your mortgage or invest.
Both camps put forth well reasoned arguments on the benefits and drawbacks of both options.
I’ve written an article on it myself along with a podcast on the same topic.
But when interest rates shoot up, as they have recently, it prompts many people to ask questions:
“Is it still better to invest when rates are this high?”
“Maybe I should pay down my mortgage since the savings are better now”
“Does debt recycling still make sense?
While these are all good choices, surely there has to be a right move on the chess board?
Let’s flesh out the options and consider what’s changed now that we have higher interest rates. I’ll also share what I’m doing and why, and how I’d approach it differently depending on my situation.
The benefits of focusing on paying off your mortgage when interest rates have risen is pretty obvious.
Essentially, you now earn a higher return on your money for paying down debt. Saving yourself 6% interest is a hell of a lot better than 2%!
The return is also guaranteed and non-taxable, making it more attractive again. There’s no volatility and uncertainty involved with paying down a mortgage. You put dollars in = balance goes down.
Not to mention, many people naturally find smashing the mortgage more motivating than investing. The higher return now makes that better – like a ‘best of both worlds’ kind of vibe.
You might also point out, “Looking back at history, interest rates aren’t even that high, they could go higher!”
That’s true, they could. And while I don’t have a crystal ball here, I do think it’s unlikely mortgage rates go much higher than they are now.
At the time of writing, economies seem to be slowing as previous rate hikes work their way through the system and affect people’s spending power (the US is a little different as most mortgages are not variable like ours).
By the way, I’m using ‘high’ as a relative term, referring to the recent decade of low interest rates. I’m well aware that interest rates have been much higher in decades past.
So what about investing? The case for investing when interest rates are higher is less obvious.
As rates go up, it makes safe options like cash and bonds more appealing. So it makes people think, “Maybe I’ll just hold off investing for now, since I’m getting such a good rate on my cash.”
This often has a counterbalancing effect of slowing or reducing asset prices, as they become relatively less attractive.
The returns of ‘safe’ assets have increased, but what about the returns on stocks and real estate? We’ll discuss this a bit more soon, but if we take a long term view, the long term expected returns are likely not that much different from normal.
Dividend and rental yields are both a bit higher, and the multi-decade growth outlook is probably about the same. By that I mean, it’s unlikely that interest rates have materially changed future rates of economic growth, profits, and productivity.
On the surface, higher interest rates have not improved the attractiveness of investing anywhere near as much as the appeal of paying down debt.
And yes, inflation plays a part here and eats into our returns, but that’s true of everything, including our spending power and relative wealth.
Let’s pivot now to look at this decision from a different angle.
If you’re on the fence on the whole mortgage vs investing thing right now, here’s what I’d ask:
What was your original choice and why? Was it investing? Or was it paying down debt?
Some would suggest that the return estimates for both are probably similar right now (perhaps 6-8% per annum for investing after tax, and 6% for the mortgage). And while it might sound strange, here’s why I don’t think that’s the right way to think about it…
Your mortgage rate, and the expected return on stocks or other investments, changes over time.
In fact, most discussion I’ve seen ignores this completely. One reason for this could be that people get overly excited about the higher ‘guaranteed’ return of paying down their mortgage. So excited that they forget to consider the bigger picture.
Those extra mortgage repayments save you 6% interest right now. But if rates fall back to 2% again, your lower mortgage balance is no longer saving you as much.
If you had invested and retained a higher mortgage balance, that same debt would now only be costing you 2% interest once again. And by that time, shares will have moved higher.
Notice how share markets have fallen as rates have increased. And what do lower share prices typically mean? Higher future returns. Maybe not immediately, but at some point.
Falling rates tend to boost asset prices (if they weren’t already growing). So with the ‘switching’ approach, you’d likely be reallocating money to investments after prices have risen.
For multiple reasons – practical, numerical and behavioural – I think it’s better to work on the general assumption that investment returns are likely to outpace the average mortgage rate over time.
But, there’s an important caveat to that.
Some people will tell you investing will outperform paying down debt with near-certainty because of the “market efficiency” I just described.
But in reality, it depends entirely on timeframes. In truth, there are many periods where share market returns are poor (even 5-10 years at a time), and paying down the mortgage would outperform.
Back in 2020, I remember seeing people saying not to lock in fixed rates of 2% or less because “variable rates always work out cheaper, it means rates must be going to fall even further!”
The point is, there are exceptions to everything, and general rules of thumb don’t always apply.
Unfortunately, returns aren’t always forecastable in advance based on valuations. You can’t know what people will want to pay for assets in 10-20 years time.
What yield will they demand? What multiple of earnings will be deemed fair? How will the economy be doing? And what will rates be at the time?
Many ‘experts’ called the US market overvalued from the early 2010s. They were hopelessly and spectacularly wrong, missing the longest bull market of all time for US stocks underpinned by a huge run-up in profits and dividends.
Anyway, investments outperforming the average mortgage rate is not a given, so this uncertainty is worth taking into account. Always consider your own psychology when making financial projections, especially around “what if this doesn’t work out like I expect?”
By the way, you can keep tabs on your annual dividend income using the spreadsheet I created. I’ve used it for years as a way to help plan my finances and watch my progress. Get it below.
Just like when rates are lower, deciding whether to use savings to invest or pay down your mortgage is a personal choice.
As always, there are pros and cons on both sides. The right move depends on which benefits you find most appealing.
On one hand, paying down the mortgage is a guaranteed return. On the other hand, investing is likely to offer a higher long term return.
Here’s a few questions to help you think it through:
1- What do you find more exciting or motivating: seeing your mortgage balance go down, or your investment portfolio go up?
2- Which outcome to you want: a debt free home, or a much bigger pile of investments?
3- Do you like the idea of lower expenses, or more income?
4- Are you planning to retire or semi-retire in the next 5-10 years?
Let’s flesh out this last one, it’s important.
You might be better served getting rid of your mortgage repayment if planning on stepping away from the full-time workforce sometime soon.
Reason being, it’ll probably make a bigger difference of your overall cashflow than having more investments.
Here’s why…
$400,000 worth of shares may produce $16,000 of investment income. But a $400,000 mortgage will currently cost you a lot more in repayments. Likely closer to $30,000.
The point is, if you’re looking at optimising your cashflow to reduce work, getting rid of a mortgage can be more impactful. Keeping a mortgage at higher interest rates increases how much you need to reach FI, which is pretty damn annoying.
If you’re in this situation, don’t get caught in no-mans land. Paying off half your loan isn’t very helpful, because you still have the same monthly repayments!
Here, you have a few smart choices:
1- Pay off the loan completely.
2- Get the bank to recalculate your repayments to the new minimum.
3- Refinance to a fresh 30 year loan term to minimise the repayments even further.
Failing to do this means you’ve dumped a bunch more money into your loan, yet not improved your cashflow whatsoever.
For those just starting their journey, or with a longer time horizon, it’s likely to be more fruitful focusing on long term investments for reasons described earlier.
If you’ve decided that investing is the more attractive option, but still have a mortgage, you may want to look at debt recycling.
To be clear, this only makes sense if you’re good at managing money and accounts and don’t mind a bit of extra complexity.
Remember, this is not about borrowing more money to invest. It’s about re-routing savings which are destined to be invested through a mortgage first.
If you’re looking at investing anyway, debt recycling is now more attractive than before. Here’s why…
Say you have a $500,000 home loan with a 6% interest rate, and $100,000 cash.
Option A: Investing without debt recycling.
Invest $100,000. Receive $4,000 of income. If tax takes 37%, you’re left with $2,500 income.
Option B: Investing with debt recycling.
Pay down $100,000 of debt (your non-deductible home loan). Redraw $100,000 and invest it. Receive $4,000 of income.
This time you can claim $6,000 of interest as a tax deduction (interest on $100,000). You can now claim an income tax loss of $2,000 on your investment, which results in a tax refund of about $700 refund (at 37% tax rate).
Let’s recap…
With both options you have $500,000 of debt. You’ve paid $6,000 of interest for the year. You’ve invested $100,000. And you’ve received $4,000 of income.
By debt recycling, the tax position changes from having to pay $1,500 tax, to getting a refund of $700. Overall, that’s an improvement of $2,200.
On the $100,000 investment, that’s a return boost of 2.2% per annum.
Now, I can’t think of many ways to juice your returns without taking more risk, but debt recycling ranks pretty damn high on the ideas list.
You can always get a tax expert to run through the numbers for your particular scenario. And a good mortgage broker can help you set up the loans correctly to make it easier. But I hope this explains the potential benefits (see my full guide for more).
As interest rates have risen, so have the benefits of debt recycling.
In general, a higher interest rate means there are more tax savings to be had. And if your tax rate is higher than what I’ve quoted, it’s more again. So if you were on the fence about debt recycling before, it might be worth a closer look.
It’s certainly one way of dealing with the annoyance of higher mortgage rates!
In short, I’m continuing to make my regular mortgage repayments, on our home and rental properties, and if there’s spare cash available, I’ll invest it.
All our debt is tax deductible, including on our place of residence. I’ve already done debt recycling after using another unusual strategy. I explained all of that in this post.
Given all debt is deductible, paying it down isn’t very attractive to me at the moment. If I was looking to semi-retire or leave work in a few years, then paying down debt would be a lot more appealing.
But in our particular scenario of already being FI, not caring about debt, and earning part-time income, investing is the winner.
That said, if money became tight or we both wanted to go travelling and not do any paid work for the foreseeable future, I’d at least think about getting rid of the mortgage to simplify our cashflow and reduce expenses.
Deciding whether to pay down your mortgage or invest is now a harder decision than before. By the way, if you know someone who’d be interested in this post, please share it with them.
When your home loan only costs you 2%, it’s easy to throw all your money into investments. But with a 6% interest rate, paying down debt becomes a lot more appealing and the winning choice isn’t so clear.
My advice (don’t tell ASIC): choose an option that aligns with your priorities, your personal goals, and your risk tolerance. Maybe it’s destroying the mortgage. Maybe you stay committed to investing. Or maybe you decide it’s a good time to start debt recycling.
Psychological factors aside, it’s best if you can pick a strategy and stick to it. Because as I mentioned, the expected savings and returns for each option changes over time.
Flip flopping from one to the other is probably just going to result in a sub-optimal outcome, with lots of ongoing uncertainty and decision fatigue around if and when you should switch options again.
Let me know what your plans are in the comments below. I’d love to hear about your current strategy in the current interest rate environment. Has it changed at all? If so, how?
Recommendation: If you’d like help with debt recycling, getting a better mortgage rate, or anything else home loan related, I can happily recommend my personal mortgage broker More Than Mortgages.
I’ve used them for 10 years now and they’ve been great. If you haven’t had your home loan reviewed for a while, there’s a good chance you’re getting screwed!
If you happen to get a new loan through More Than Mortgages, this blog may receive a small commission at no cost to you. I only recommend things I use myself and genuinely approve of.
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Cheers Dave, very nice read and that debt recycling example was really clear to understand, thanks for that…
I personally chose the paying off PPOR debt route. Almost a decade ago, I decided that I will make use of the low interest environment back then to pay of my mortgage in 10-12 years max and i’m still on track to do that in next couple o years.
My thinking was very simple. Paying off non deductible debt and also freeing up cash flow later on to invest or work less. I have an IP in a Sydney blue chip area that is positively geared and thought that I want the freedom of not having a mortgage and also thought that the low rates environment won’t last forever so might as well make use of it.
On the other end of things, many friends doubled down on debt and expensive housing and unfortunately starting to feel the heat from rate rises.
For me , not having a mortgage was and still is the most important goal personally, and financially, my cash flow has been steadily rising and at around 40 with a above average wage, I still have plenty of time to Invest hard if I chose to.
Sounds good to me mate, and interesting to see the comparison with your friends who took a different approach. Thanks for sharing.
Thanks Dave,
The article is very good timing for me – I have an IP on the market and will (hopefully) have the very fortunate option of paying the PPOR off or debt recycling the whole mortgage in one go.
I like that you acknowledge that for FI the paying off option actually is more likely to create more freedom. That is often missed in the pay down vs invest arguments.
That said, I am still on the fence (and largely have been for the last two years – which has been good timing given the high rates and sideways market movements). I am beginning to think the best course of action is to burn the boats! (i.e. whatever I do, avoid leaving cash in an offset / redraw which means I always second guess whether I should be investing).
But leaving cash in the offset is the clear winner whilst u decide what to do? Ur not passing non-deductible interest but can debt recycle down the track if you decide to go down that route?
It’s not an easy decision to make. Well depends on your priorities, being freedom and simplicity, or greater gains. If freedom, then pay off the PPOR and that’s it. If it’s gains (or may be), the first thing to do is pay it off, then you can always decide to pull it back out again at anytime. If you were going to invest it anyway, the smartest move is to pay off the loan first to debt recycle for tax efficiency. But make sure your bank will keep the facility open for you, because I know some of them close it if your balance hits zero. Alternatively leave a little balance outstanding.
I’m really torn on this so thank you for the article, super helpful.
We have ~500k of investments outside the PPOR (~375k IP equity & 125k shares outside super).
I’m considering selling the IP (a unit) next year because the proceeds could go in to our offset and ‘fully offset’ our home loan. We’d then save over 2k a month in interest while rates are high, and use our 5-10k surplus each month to quite rapidly DCA back into shares (VAS etc).
The idea of being fully offset, and not paying so much ‘dead’ money to the bank, is an appealing one. I also like the idea of converting the property investment into shares for similar reasons you’ve written about in your articles.
Thanks again for the brilliant and timely post 🙂
Hey Nathan, glad you like the article! You’re in a great position so any option here is good. I suppose it depends whether you’d rather keep the IP for possible gains, or you’d rather go the simpler more certain route of zero mortgage interest and plowing into shares. Sounds like you’re leaning more towards the latter.
Thanks Dave, Why not do a bit of both? Pay down extra on the mortgage, salary sacrifice to super and build some investments outside of super. It does not need to be all or nothing on each option.
Because of the ‘no mans land’ example I gave. It’s more efficient to focus on one or the other. The lens I’m looking at this is one who wants to create freedom and leave work. But if you have no desire to stop working anytime soon, then sure, it doesn’t matter, do all of them.
At the end of the day, it really depends upon your goals which you have alluded to. If you have recently taken out a mortgage, I would imagine that paying down that debt is front and centre. If you have managed to build up some equity over the years, then the investing option takes on more relevance. For those wrestling with this dilemma, it should be remembered that the home first and foremost represents security of tenure and that should be respected.
Thanks for the article, Dave. It’s a good topic to revisit when changes occur. I think we all have to weigh up all of the factors, e.g. these days we, and almost all of our peers, have had to help our adult children get into their first home purchase. We, at 70+ years, borrowed against the huge equity in our PPOR to help our kids, and we don’t regret it at all. There is no way that they could have saved a deposit otherwise in eastern Australia. Which is a crazy situation, and totally not how it should be!
I decided to try the debt recycling about 2 years ago. It sounds good in theory but the potential loses outweighed the potential gains in my personal situation. Long term it would probably work out but I couldn’t cope with the possibility of owing money on something that has decreased in value.
I’m more comfortable paying of the mortgage in full and then saving to buy shares/ etfs. You may think you have a high tolerance to market fluctuations until the market goes down.
You’re confusing debt recycling with borrowing to invest, or with investing vs paying down debt. Debt recycling does not consist of increasing your debt whatsoever, but simply moving money through a loan before you invest it. So it’s actually impossible for the ‘losses’ to outweigh the gains. Unless of course you’re comparing paying down debt with investing, which is a different discussion. Debt recycling assumes you have already decided to invest with your existing savings vs pay down debt. But I totally agree with you that it’s not for everyone and some ppl are just better off paying down their mortgage in practice.
Awesome. I don’t really understand where franking credits would fit in though. How does the 100k, 4k dividend example play out if it was 100% fully franked?
If you have a 4% fully franked dividend, it becomes 5.7% when franking is included. So then we’re using an example of 5.7% income. If no debt recycling, then $5,700 of income means roughly $3,600 after tax ($400 tax to pay out of pocket after franking credits are utilised).
If debt recycling, then $5,700 income declared, $6,000 interest declared, leaves $300 taxable loss. Results in minimal refund of bout $100. So a $2,000 difference in overall tax outcome by debt recycling vs not. Hope that makes sense.
Hi Dave,
So the net cash position is 300$?
Thanks for clarifying.
I’m personally paying the minimum in my mortgage, but primarily my spare cash is going into shares for the reasons you state.
One aspect in debt recycling during tougher economic conditions that needs to be considered is that lenders are less likely to lend (or lend as much). Because the risk of a default is higher. I’ve recycled in the past – just before the GFC, which compounded by share market loss, coupled with a loss in income. I was forced to sell at a loss. Once bitten – twice shy.
Using history as a guide, one overlooked aspect is the affect of Inflation on Debt. In the early 70’s my grandparents had a $5000 family home loan. Seems like nothing today – and that’s kind of the point: inflation was 17% at the time, and pushed wages higher quickly. And that $5000 debt quickly became insignificant over time (despite 15% interest rates). So effectively one of the few benefits of inflation is that it erodes debt.
Great point about inflation and debt. I think we’re so used to inflation being pretty benign since the GFC that we forget its effect on debt. I think most of us in this space intuitively know how it works, but we probably should spell it out a bit more often “the value of this debt actually reduces every year in real terms”
Great article, Dave. Our situation is that we had fully paid off our mortgage about 7 years ago and had since been throwing all savings into low cost index ETFs. About 12 months ago, we reborrowed a “small” amount against our home (around $50K) for a landscaping project for our backyard. This was just around the time that interest rates went on their long upward run. Despite that happening, it hasn’t changed our strategy from when we first reborrowed which was to repay an amount quite a bit higher than the minimum monthly payment on the mortgage, while still continuing to funnel all other savings into ETFs each month.
My plan is to at least semi-retire four years from now by which time I anticipate the mortgage will once again be fully paid off and we will have remained on target to achieving the FI number that we’re aiming for through continuing to invest.
Perhaps this may be seen as sitting somewhere in the middle, but given the level of mortgage debt is small in a relative sense, it’s a strategy that does align with our goals so we’re comfortable with this approach.
I am currently devouring every debt recycling article I can find to determine whether it is a strategy that would suit us (dual income, PPOR $665k mortgage). This was a great article.
I can’t seem to find any articles that show me what people do when the loan is full converted to a tax deductible entity and then folks want to pay it off with their dividends? Are there any blog posts or calculators that you know of that can show me how a loan can be paid down? Peter Thornhill doesn’t cover this, and there is a small mention in Canna Campbell’s Mindful Money about paying it down. But that’s it.
Hi Kelly. If you want to pay it off after it’s fully converted you just start putting all your surplus into the loan – spare monthly savings + dividends when you get them – there’s nothing else to do. Just like you do when you want to pay down a normal loan, it’s no different.
Excellent point about no-mans land when paying down the mortgage aggressively!
I’m in a rather unique position as I have two non-deductible mortgages – my own, and my parents’ house – and fairly tight cash flow as a result of all the interest rate hikes recently. I also have a deductible investment property mortgage but with recent rate rises its back to being negatively geared.
Paying of my own mortgage instead of investing doesn’t make sense to me because its a big mortgage, and will take 20 years to knock off. That’s a long time to avoid investing!
Paying the investment property doesn’t make sense either as it’s tax deductible.
My parents’ house on the other hand, has a split mortgage and one of those portions I could easily knock out in 3-4 years. So my plan is to knock out the smaller loan (100k), NOT debt recycle because the point is to free up cash flow. The other portion of that loan I could potentially pay off in 10 years if I divert the freed up cash flow there… but sort of leaning towards slow paying that one and invest the difference. Depends how the cash flow situation is going in a few years time.
Solid article as always dave and a very relevant one considering current interest rates.
Without really planning it at the time, we paid off our PPOR for us in a DINK scenario and 1.99% rates we were able to achieve this quite quickly…
Moving forward we now max salary sacrifice into our super accounts and DCA monthly with our cashflow into ETFs I feel that now having no PPOR mortgage we are living life almost in cheat code with the combination of no stress and high cashflow
To the above comment written by Kelly, I think with a debt recycling strategy what to do with the tax deductible loan that is left it would be best to have a exit strategy ie have the potential to pay off via selling other investment, selling down some shares, If you are likely to receive a inheritance or even plan to use a portion of your super to remove it when it’s accessible.
Cheers dave!
Very nice Stefan! Definitely playing life on easy mode once you have no mortgage 😉 Results in tons of spare cash as you say which enables rapid investing or ability to work a lot less.
Another good article Dave! Can you recommend a good tax agent here in Perth to run through the numbers, specifically for debt recycling?
Cheers Mark! Sorry I don’t have any good contacts locally for that. I really should work on building out a network of trusted contacts for people to go to, just haven’t got there yet!
Hey Dave
I listened to your ebook before Xmas and have become obsessed with the idea of FI or semi FI.
We have 2 young kids (3and 5) and currently own and live in a 2 bedroom unit on the northern beaches, sydney. We have 600k left on our mortgage with 200k of that available to redraw (due to an inheritance).
We’re both just about to start new jobs with higher salaries so I’m pumped to start putting all that excess cash into either the home loan or vas/vgs.
I know you’ve said not to get stuck doing both.
What if.. We refinanced down to 500k to reduce our monthly payments, then just pay the minimum. And then invested 50k through debt recycling followed by any extra cash that we save each month (approx 6k).
Would that make it any less no man’s land?
I’m just mindful that we’ll likely want to sell and then buy a bigger place (with bigger mortgage) in the next few years. I would love to invest all of the cash but I feel like we’d need it to buy our next property. If this is the case would we be best off just smashing this home loan to give us more cash for when we sell and buy the next place. Or would we be best off to put all the money into shares to have those bigger dividends coming in to help pay the bigger mortgage down the track?
Hey Hannah, welcome to the club 🙂
That sounds perfectly fine. The only issue with ‘no mans land’ is where you don’t get the benefit of lower mortgage repayments but have stuffed a bunch of savings in there. But if you refinance to extend the loan term or a new minimum, then you do get that cashflow benefit.
As for whether you invest it or use for your current mortgage, I’d decide based on your end goal. Is it to have a completely paid off home as part of your FI/semi Fi plans? Or are you happy to keep the mortgage and have a bigger portfolio to help pay for it? Figuring that out will help you decide. Both work as I’ve covered so it’s about which one you prefer.
Great article, thank you Dave. We are in a fortunate position where we have enough cash in the PPOR offset account so it is “paid off”. Researching on whether we should pay down IP loan or debt recycle to invest in ETF now. We are on highest tax bracket in our late 30s. I’m too scared to make the wrong move!
Glad you like the article Sally. Great position to be in, nice work!
Hmm, so basically contemplating which option suits you best. It sounds like you might be conservative given your fear of making the ‘wrong’ move. First thing to understand is that there’s no wrong approach – just varying types of good strategies with pros and cons.
Do you want to grow your investments or get rid of your debt? Which one of those excites you more? Investing tends to reap greater returns, and if debt recycling is quite tax efficient, especially compared to paying off an IP (which is deductible debt). But if you find it more motivating to destroy a mortgage balance + like that conservative approach, then there’s nothing wrong with that.
thank you Dave, great article, and you book totally changed my view towards investing/life. like Sally in previous post, I have a fully offset PPOR . Plan to start investing $40,000/year, Researching on whether I should direct invest or debt recycle to invest in ETF while keeping same amount of money in a saving account so the overall debt level stay the same ($0 hopefully or at least no more than 10% of the mortgage). I’m single in my mid 40s on highest marginal tax rate.
Cheers Dave.