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The topic of paying off your mortgage quicker by contributing more on a month to month basis or rather utilizing those extra disposable funds to invest in other investments has been an ongoing debate for decades, especially during the Covid-19 pandemic as we have seen interest rates globally fall to record lows.
Paying off your mortgage to reduce your debt repayments and ultimately the interest that you are paying to service this debt has always been an advisable thing to do but the issue comes when you have ignored the key to building a stable financial plan which is diversification in your wealth creation plan.
In order to answer this very popular question, we need to take into account two different views or opinions on this matter: Firstly the more traditional view that one needs to pay off home loans and any other debt as quickly as possible to avoid high levels of debt or debt-servicing costs, and then a view that investing your extra cash into an investment instrument or basket of diverse investments can be more rewarding over the long run.
Let’s pick apart the pro’s and con’s of each:
Investing your extra funds:
Paying extra into your mortgage will definitely save you interest but what this means is you completely limit your ability to create a basket of investments that can help protect you if for example the property sector had to crash or you were to hit financial trouble. If you have a diverse exposure to a basket of asset classes (equities, property, bonds and cash, both local and foreign) and keep in mind the various tax benefits that some investment products can give you, you would be far better off using any extra disposable income to have “many eggs in many baskets”
Portfolio diversification is particularly important, and we always encourage investors to spread their risk and not be too concentrated in one asset class. In a well designed financial plan we like to think of it as a bicycle wheel, and each spoke of the wheel represents a different investment, if one spoke were to break or in this example fail or crash, the bike would still be okay to ride, however if you only had one spoke and it broke, you wouldn’t be able to ride the bike.
Putting all your money into a bond will mean you have 100% exposure to property and will have all your eggs in one basket.
Different asset classes tend to perform differently during certain economic cycles, and therefore diversification will add value to your overall investment portfolio.
Especially during the Covid-19 pandemic many countries have significantly dropped interest rates to help ease off pressure on the average consumer or those servicing debt, this has actually made it an even better idea to invest in other assets or funds that can outperform the low debt servicing cost.
Paying off a mortgage:
“People have been advised over the years that having debt, especially a high interest rate mortgage is bad and should be avoided or at least reduced as quickly as possible. If you are to pay an extra lump sum into the mortgage this will allow you to pay off the capital portion sooner, which reduces the term of the loan and hence reduces the total amount of interest paid. A key aspect to acknowledge is that unless your mortgage has an access facility, that money is locked in that mortgage until sale of the property, and this can cause complications especially if you do not have an emergency fund built up and something happens which requires you to access urgent cash, this is why it is so important to be guided through the home buying process by a professional”. says Desigan Naidoo, CEO of Omega Property Group and Omega Mortgage.
If you decide to invest the money, you can select an option that provides easy access to your funds should they be required such as a unit trust or call account. Considering the situation we find ourselves in whereby many individuals are taking salary cuts or losing income, keeping all your money in your mortgage can be quite risky.
It is important when considering how you wish to make use of any disposable income to be well-informed or speak to a financial professional who would be able to personally assess your situation and provide you with options to make the correct choice tailored to your personal financial situation. Yes debt is not great, but diversification in wealth building is critical for longevity!