The current low interest rate environment has a lot of clients asking me whether now is the time to focus on paying off their mortgage.
And the strange circumstances we find ourselves in, with 2020 not turning out how any of us imagined, has many asking whether they should focus on investing, either in stocks or property.
It’s an interesting conundrum.
It seems like a good time to future-proof your finances in light of the uncertainty that lingers both here in Australia and in the rest of world. But at the same time, there are some unique opportunities to put cash in either the share or real estate markets, with some good potential upsides on offer.
So, what should you do? Repay your mortgage while you get exceptional bang for your back, or put that fiscal power towards an investment?
Debt is cheap
If you’d told me a decade ago that we’d be in a position where the Reserve Bank’s interest rate would have a zero in front of it, I might’ve fainted.
And yet, here we are, in the lowest rate environment ever experienced, making debt extremely cheap – and, while it lasts, probably the cheapest we’ll see it in our lifetimes.
You only need to look at the past in context to see how low it is.
The official cash rate in Australia has had a wild ride over the past 30 years, averaging 4.23 per cent between 1990 and 2020. At its peak, it reached a whopping 17.5 per cent in January 1990, during the “recession we had to have”.
Right now, it’s at an all-time low of just 0.25 per cent, thanks to a sluggish economy pre-coronavirus, as well as the need now to get the country firing again.
Many of my clients are asking whether they should take advantage of that low rate that has pushed home loan interest to rock bottom levels and pay off their mortgage balance.
It’s a worthy idea. Your home loan is in all probability going to be the biggest debt you’ll carry in your life and chipping away at it faster is a wise notion.
But on the flipside of that, I’m being asked whether clients should make full use of debt being so cheap by deferring interest, reducing payments and sitting on their balances while it doesn’t cost much to do so.
Again, this is not a ridiculous prospect, but it comes with its own set of risks.
Yes, the current low-interest climate we find ourselves in makes it very cheap to carry but, but by deferring interest payments now, you’re only adding to the loan down the track.
Where do you sit?
Any question about your finances should always be viewed in light of your current circumstances.
What’s your cash flow like right now? Is it tight or do you have some good room to move?
Do you have a lump sum of cash, or have you exhausted your savings nest egg?
And more than that, what are your circumstances going to look like down the track? In six months, twelve months, or twenty-four months?
As we know, the world is a little uncertain right now and some of us are in positions that could shift in the short to mid-term.
The last thing you want to do is burn through reserves that could get you through a rainy day. But at the same time, you might not want to miss out on the chance to use cash – or defer it – for a solid investment opportunity
The cost of opportunity
In addition to considering your financial circumstances, it’s important to consider the cost of opportunity.
That is, what is the value of repaying your mortgage versus the value of investing in stocks or real estate?
It could be that your position is solid and you’re comfortable with seeking out opportunities in the share market, which – while volatile – is performing well in certain segments at the moment. Or, you might want to jump in to the property market, where reduced competition and some jitters mean there are some bargains with good long-term prospects to be found.
Considering the opportunity cost should be done with a long-term view. What are your financial goals? What are you hoping to achieve? What can you do to get you closer to those dreams?
Are you thinking about retirement, where reducing your debt and boosting your future cash flow could be the aim? Or are you keen to build your wealth through investment?
Are you in a position to cash in on the increased value in your principal place of residence and use the profit, tax free, for a new home, an investment, or both? Perhaps you’ve been working the sums on a development project?
Having a clear idea of where you are right now, where you want to be down the track and the things you can do to get there is absolutely crucial before you make any decision.
All in all, the conversation should be dependent on your own financial circumstances and is best determined with the help of an independent, properly qualified and experienced professional advisor.
Intuitive Finance is exceptionally placed to help you navigate this part of the equation to help you form a clearer picture of what you might do in the months ahead.