Pay Off Your Home, Invest, or Debt Recycle: Which Should You Choose in a High Interest Rate Environment?

When setting financial goals that revolve around building wealth, we generally see clients tossing up between a few different options. These usually include paying off their mortgage, investing, or recycle debt in a high interest rate environment.  If you’re curious about the best way to build wealth that aligns with your financial goals - especially when interest rates are high - read on.   

What is the best option for me? 

When it comes to the best wealth-building option when interest rates are high (note: ‘high’ means something different to everyone), you’ll first need to consider your short, medium, and long-term financial goals. Here are some typical wealth-building strategies we assist our clients with. 

Paying off your mortgage 

When it comes to your mortgage, paying off your home loan in a high-interest rate environment means you’re earning a higher return on your money while paying down debt. While an interest rate of 2-3 per cent is nice, you’ll save much more when putting down money on a 5-6 per cent loan. When you pay down the debt on your mortgage, you know where the money is going—when your money goes in, the balance goes down, and you get closer to financial freedom.

Investing 

When interest rates go up, ‘safe’ options like cash and bonds can appear more tempting. Even so, higher interest rates haven’t overtaken the appeal of paying down your mortgage sooner. However, investments outperforming the average mortgage rate are not a given, so this uncertainty is worth taking into account. Investing can be a good strategy if it aligns with your financial goals. Looking at it from a long-term perspective though, it’s unlikely your expected returns will be significantly different over time. The market and its returns are prone to change, so it's common to see a fluctuation in your investments. 

Debt recycling 

The third option, if you’re adept at managing your money and can deal with a little more complexity, is the practice of debt recycling. Debt recycling is a way to reduce your personal debt against your house and then use the equity in that house to recreate the debt and invest the money. As the name suggests, you’re recycling your debt from personal (non-tax-deductible) debt to investment (tax-deductible) debt. Step by step, debt recycling will look a little like this:  Step 1: Access the equity in your home Step 2: Borrow against your home Step 3: Wait for the gains Step 4: Embrace the cycle There are plenty of other benefits stemming from debt recycling. These include building your investment portfolio, potential tax benefits, a passive income and the opportunity to pay off your mortgage faster.  To learn more about debt recycling, read our blog.  With higher interest rates, debt recycling is becoming an increasingly popular option. For example: 

Investing without debt recycling  

In this scenario, you invest $100,000 and receive $4,000 of income. If tax takes 37 per cent, you’re left with a $2,500 income.

Investing with debt recycling 

In this scenario, you pay down $100,000 of debt (your non-deductible home loan). From here, you can redraw $100,000 and invest it, receiving $4,000 of income. What makes this scenario different is you can claim $6,000 of interest as a tax deduction (interest on $100,000). From here, you can claim an income tax loss of $2,000 on your investment, which results in a tax refund of about $700 refund (at 37 per cent tax rate). In both scenarios, you have $500,000 of debt and you’ve paid $6,000 of interest for the year. $100,000 has been invested and you’ve received a total of $4,000 income.  Through debt recycling, your tax situation shifts from needing to pay $1,500 in tax, to acquiring a $700 refund - an overall improvement of $2,200 or a return boost of 2.2 per cent annually. 

Which one should I choose? 

If your mind is racing and you’re unsure which option is best for you and your financial situation, take a step back and review your financial goals. You can enlist the help of an Inovayt financial advisor to help you decide.  As for deciding whether to pay down your mortgage, invest, or engage in debt recycling strategies, there are a few questions you can ask yourself to help you make your decision.  Firstly, which option motivates you the most? Is it the appeal of seeing your mortgage balance decreasing that excites you? Or would you prefer to grow your investment portfolio?  The next question to ask yourself centres on the end goal you’d like to achieve. Would you like to live in a home where your mortgage is paid off or would you prefer a more significant pile of investments? Do you like the idea of lower expenses or more income? Lastly, consider if you plan on retiring or semi-retiring in the near future (5-10 years). This will significantly impact which decision will work best for you. 

Can an Inovayt finance professional help me build my wealth?

With higher interest rates than what we’ve seen in the past few years, choosing whether to pay off your mortgage, invest, or undertake debt recycling strategies can be a complex decision. With the help of an Inovayt professional, know you’re making the best decision to meet and exceed your financial goals.