Invest in the market or pay down your mortgage?

Every Australian homeowner has likely faced this dilemma: should spare cash go towards the mortgage, or into the market?

With interest rates higher and proposed capital gains tax reform on the table, the question has become more timely.

Proposed CGT changes could also affect the after-tax return from investing. From 1 July 2027, the government proposes to replace the current 50% CGT discount with one based on inflation, and bring in a minimum 30% tax on real capital gains.

The impact will vary most depending on the type of investment you hold. Australian equities, for example, tend to deliver more of their return through dividends and franking credits than pure capital growth, which can mean a lower tax bill under the new indexation rules. Other factors like your income, holding period and inflation will then determine your final position.

It’s also worth noting that for some investors, the most tax-friendly option sits outside this debate altogether. Concessional super contributions are generally taxed at 15%, which is usually lower than a person’s marginal tax rate. Over the long run that can add up, provided you’re comfortable with the trade-off of locking your money away until you can access your super.

So how do you decide? The truth is, like many things in life, there’s no silver bullet. The right answer depends on your mortgage interest rate, your investment horizon, your tax position and your risk tolerance among other factors. Let’s break it down.

A good place to start is what’s known as the expected return approach. The idea is simple: compare your mortgage interest rate against the return you’d expect to earn by investing that same money in the market.

The catch is that you need to compare them on a like-for-like basis. Investment returns are made up of two parts: any income you receive along the way (like dividends), and any capital gains you realise when you sell. Each part is taxed separately. On the other hand, every dollar of mortgage interest you save is already after-tax, because you can’t claim interest on your home loan as a tax deduction. It’s also worth remembering that paying down the mortgage is a sure thing. Investing in the market isn’t. Markets can go up and down, and there’s no guarantee your returns will be the same as the long-term averages over your specific investing window.

So if you reasonably expect to earn more from investing than you’re paying on your mortgage, even after tax and fees, the maths leans towards investing. If not, paying down your mortgage is likely the smarter move.

For context, the S&P/ASX 200 Index has historically returned 8.2%¹ per year including dividends since 29 May 1992. If your mortgage interest rate is sitting at 6% and the ASX 200 continues to perform as it has done historically, the expected return approach would suggest investing could be the more rewarding choice.

There’s something very satisfying about slowly and methodically chipping away at your mortgage. And it’s not just emotional: every extra dollar you repay is a dollar you’re no longer paying interest on. With the RBA keeping rates elevated, that’s a meaningful saving.

Paying down the mortgage can also impose financial discipline because the money is no longer sitting in your everyday account.

Many Australians also want to enter retirement mortgage-free. In a recent study, Colonial First State found that 28% of Australians approaching retirement have a mortgage, while 14% of retirees are still carrying one².

An offset account can offer a useful middle ground. The balance reduces the interest charged on your loan, while your money remains accessible if your circumstances change.

Here’s the other side of the story. Every dollar that goes towards extra mortgage repayments is a dollar that can’t be working for you in the market.

Imagine someone with $2,000 of disposable income each month. If they put all of that into extra mortgage repayments, they save themselves a chunk of interest over the life of the loan. But if they instead invested that $2,000 each month in an index tracking fund, like one that tracks the ASX, they could end up with more than $1.2 million after 20 years, as the S&P/ASX 200 Index has returned 8.2% per year including dividends since 29 May 1992³.

That’s the power of compounding.

Investing also gives you something that extra mortgage repayments can’t: flexibility. Money invested in ETFs is generally liquid; if your circumstances change and you need access to funds, it’s still available⁴. Money tied up in extra mortgage repayments can be much harder to pull back out, with redraw rules varying lender to lender. An offset account is the exception, since it keeps your money fully accessible while still reducing the interest you pay.

What does this all look like with real numbers? As we noted earlier, the market needs to clear the mortgage rate by a margin to compensate for the tax drag on investment gains.

Imagine a 35-year-old Australian, on the top marginal tax rate. They have a $500,000 mortgage with 20 years left to pay off, a 20-year investment horizon and $2,000 of surplus cash each month. At a mortgage rate of 6%, the market would need to return around 7.7% pre-tax. If rates were to rise to 7%, then the required return would be roughly 9.3%. The required spread typically sits between 1 and 2.5 percentage points, and it widens at higher mortgage rates because the tax bill on the investment grows with the size of the return⁵.

So, in this scenario, the 8.2% historical market return would clear the 6% mortgage rate hurdle, but only just. The decision is finely balanced and depends heavily on whether forward returns match historical returns. The results will also differ materially based on each variable such as mortgage balance, mortgage horizon and the assumed inflation rate.

For most people, the smartest approach isn’t picking a side. It’s doing a bit of both.

Here are three things worth thinking about:

1. Match the strategy to your goals: Money you need in the next few years should sit in an offset account, where it stays liquid but still works to reduce your mortgage interest. Money you don’t need for the next five to 10 years is a strong candidate for the market, where time can help smooth out short-term volatility.

2. Be honest about discipline: Mortgage repayments are forced. Investing is voluntary. It’s easy to say you’ll invest the difference, but a lot of people don’t. If you know you’ll struggle to invest the money each month, automating it can take the decision out of your hands. Platforms like Betashares Direct have an auto-invest feature that lets you set up recurring investments into your portfolio, so the money can be put to work right away without needing frequent monitoring.

3. Diversify your approach: By splitting your extra cash between the mortgage and investing, you will generally make financial progress regardless of which strategy comes out ahead long-term. If the market underperforms, you’ve still made progress on the mortgage. If interest rates fall, your investments are doing the heavy lifting. Either way, you’re moving forward.

The real risk in this debate isn’t picking the wrong strategy. It’s picking no strategy at all.

Whether you lean more heavily towards paying down the mortgage or investing, the important thing is that you are putting your money to work. Because the one thing that’s certain is this: doing nothing has a cost too.