Do you shy away from risks or are you a risk taker? In general terms, if you shy away from risks you should aim to pay off your mortgage as early as possible by making additional repayments. Investors with a higher risk appetite may favour the idea of investing in a second property instead.
Reasons to pay off your mortgage early
The beneficial effects of paying off your mortgage is very calculatable and predictable. Being in control of your investments is the key to reducing your investment risks.
The mathematics to calculate the benefits of paying off your mortgage early is quite simple. When you hold an active mortgage, the interest charged to you is calculated daily on the amount you owe and is accumulated until you make a repayment. When you make a repayment, you first pay off any interest accumulated, any leftover is used to pay off your mortgage. For example, if you have $900 accumulated in interest and your repayment is $2,000, after interest, you will be paying off $1,100 of your mortgage. Next month, you will be charged slightly less in interest as you now have a slightly smaller mortgage. In this example, only 55% of your $2,000 repayment went into paying off your mortgage. The only way to pay off your mortgage faster is through additional repayments, as 100% of it goes into paying off your mortgage which affects your subsequent interest charges. What this means is, additional repayments towards a mortgage is particularly important in earlier years of your mortgage. For a graphical representation of the effects of additional repayments, you can check it out here.
If paying off your mortgage early is your thing, you may like to read about John and Anna's story who have managed to pay off their mortgage in just 5 years.
Buying a second property
If you decide to buy another property instead of paying off your mortgage early, please remember to consider any opportunity costs involved. The most important question you need to ask yourself is “is the extra risk and expected capital growth of this second investment worth the interest I would have saved?”. In relative terms, in most cases investing in a second property, you will likely incur significantly more ongoing expenses, that is expenses from your new property and extra expenses from your existing mortgage. This effectively means you would be purely banking on the potential capital growth of the new investment. Looking at how the property market performed over the past few years, the decision to buy a second property over a paying off your mortgage early would seem quite reasonable. However, going forward, it’s up to you as the investor to assess the property’s growth potential in the upcoming future.