You have some spare cash each month. Should it go onto the home loan, or into an investment portfolio? It is one of the most common money questions in Australia, and the honest answer is that it depends on a handful of numbers. This guide shows what those numbers are, and how much difference they make over 30 years.
The example household
The household in this example has:
- a $600,000 home loan over 30 years at 6.0% a year, so repayments of about $3,597 a month
- an extra $1,000 a month to put somewhere, every month for 30 years
- a 32% marginal tax rate (the 30% bracket plus the 2% Medicare levy)
They compare two choices.
- Pay the loan off first. The extra $1,000 goes onto the loan. Once the loan is gone, the whole $4,597 a month (old repayment plus the extra) is invested until year 30.
- Invest from day one. The loan runs its normal 30 years. The extra $1,000 is invested every month from the start.
The investment is a diversified share portfolio returning 7% a year before tax: 3% as income (taxed each year at 32%, then reinvested) and 4% as growth in value. At year 30 we look at the portfolio both before and after selling it, because selling triggers capital gains tax (CGT) on the growth, with the 50% discount for assets held over 12 months.
What happens
Paying the loan off first clears it after 17 years and 8 months instead of 30 years, and cuts total interest from about $695,000 to about $374,000. That is roughly $320,000 of interest never paid.
At year 30, with the loan gone in both cases:
| Pay loan off first | Invest from day one | |
|---|---|---|
| Portfolio value | $1,005,000 | $998,000 |
| After selling and paying CGT | $971,000 | $931,000 |
In this example the two choices end up close. Paying off the loan first is about $7,000 ahead if the portfolio is kept, and about $40,000 ahead if it is all sold at year 30, because more of that portfolio is money put in rather than taxable growth.
When the numbers change
Change the loan rate or the investment return and the result moves a long way. The table shows how much further ahead investing from day one finishes after selling at year 30. A negative number means paying the loan off first finishes ahead.
| Loan rate | 5% return | 7% return | 9% return |
|---|---|---|---|
| 5% | −$100,000 | +$71,000 | +$360,000 |
| 6% | −$196,000 | −$40,000 | +$232,000 |
| 7% | −$304,000 | −$166,000 | +$85,000 |
In each case the income part of the return is 3% and the rest is growth. The pattern is consistent. When returns after tax are well above the loan rate, investing pulls ahead. When they are below it, paying the loan off pulls ahead. Over 30 years small differences in either rate compound into large amounts.
What the numbers leave out
The sums above are only part of the picture. Other things that matter:
- Certainty. The saving from paying down a loan is known in advance. Share returns are not. Over 30 years a 7% average still includes years with large falls, and the order those years arrive in matters.
- Access to the money. Extra repayments sit in the loan. Some loans let you redraw them and some restrict it. Money in an offset account reduces interest the same way while staying in your own account. See offset vs redraw.
- Franking credits. Australian shares often pay franked dividends, which lowers the tax on the income. That would tilt these results towards investing. The example ignores franking to keep it simple.
- Fees. Investment fees reduce the return each year. Loan fees and break costs can matter too.
- Rates move. A loan rate that changes over 30 years changes the answer too.
- Super is a third option. Extra money can also go into super, where contributions are taxed at 15% but can't be reached until retirement. See how salary sacrifice works.
The assumptions in full
- Loan of $600,000, 30-year principal and interest, 6.0% a year, repayments monthly.
- $1,000 a month extra for 360 months.
- Portfolio return of 7% a year: 3% income and 4% growth, each an annual rate applied monthly so a year compounds to exactly that rate.
- Income taxed at 32% each year and reinvested. No franking credits.
- CGT at year 30 on growth only, with the 50% discount, at 32%.
- No fees, no inflation adjustment, no change in rates or income over 30 years.
Run your own numbers
Every household is different. MyFinancialFuture lets you model paying down a loan, investing, or both with your own income, loan and super, month by month, for free and without an account.
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