Why investing extra money from a rate cut can be a better long-term option.
Millions of Australians holding variable rate mortgages are about to receive a monthly household cash infusion, thanks to the Reserve Bank’s 0.25% cash rate cut on 20 May.
Based on an outstanding mortgage balance of $600,000 with 25 years remaining on the loan term, a 0.25% rate cut from 6% to 5.75% will reduce monthly repayments by $91 per month.
Combined with the Reserve Bank’s 0.25% rate cut in February, and using the same loan numbers as above, those with a $600,000 mortgage now have $183 per month more in their pocket than at the start of the year.
The decision on how to invest a mortgage interest rate cut will really depend on your personal circumstances and financial goals, your attitude to risk and potential cash needs, the amount of debt outstanding you have, and the overall cost of servicing it (interest charges and fees).
Weighing up your options
With extra cash in hand, you may be wondering if it’s smarter to use it to make higher monthly repayments than necessary to pay down your mortgage sooner? Or does it make better sense to invest some or all of that extra money somewhere else, such as in growth assets such as shares?
Reducing the amount owing on your loan will reduce monthly repayments, and could potentially reduce the total interest charges on your outstanding balance and the overall term of your loan.
On the other hand, investing additional funds into other areas could potentially offset the overall interest costs of your loan over time if the net returns from those investments end up being higher.
Here are some calculations to map out some possible financial scenarios based on mortgage interest rates and historical share market returns.
Making higher payments
Here’s how the numbers stack up on a $600,000 mortgage for someone choosing to keep their monthly repayments unchanged at the same amount they were back in February when mortgage rates were 0.50% higher.
Assuming a 6.25% mortgage rate back then, the monthly repayments on a 25-year loan were $3,958 (assuming no fees). The total interest that would have been payable over the term was $587,412.
By choosing to keep monthly repayments at $3,958 (instead of dropping them down to the $3,775 due on a lower 5.75% loan rate) the total interest that would be payable over the term of the loan would reduce to $473,084 and the loan term would decrease from 25 years to 22 years and eight months.
Over the term of the loan, that would equate to a total interest saving of $114,328.
Investing into growth assets
So, how does that number compare with an investment strategy?
As a comparison, they’ve used the historical 8.2% average annual return from the Australian share market over the last 25 years, between the start of April 2000 and 30 April 2025, to see how a $183 investment per month (the amount of monthly mortgage savings on a $600,000 loan at an interest rate of 5.75%) would have added over time.
The 8.2% per annum total return from the Australian share market is based on the performance of the S&P/ASX All Ordinaries Total Return Index and assumes all investment income earned over time was reinvested. The return number excludes any acquisition costs, fees and taxes.
An initial investment sum of $183, followed by monthly investments of $183, would have compounded to $181,214 over 25 years. This would have been made up from a combination of capital growth and reinvested income distributions.
The total compound growth from the Australian share market is $66,886 higher (on a 25-year historical basis) than the total interest savings ($114,328) achieved from using an extra $183 per month to make higher mortgage repayments.
Investing in an index is not possible, but such a broad share market strategy could be achieved by making regular investments into an Australian index tracking exchange traded fund such as the Vanguard Australian Shares Index ETF (VAS), which invests in the top 300 stocks on the ASX.
The bottom line
The decision on how to invest a mortgage interest rate cut will really depend on your personal circumstances and financial goals, your attitude to risk and potential cash needs, the amount of debt outstanding you have, and the overall cost of servicing it (interest charges and fees).
Australians are big users of mortgage offset accounts – transaction accounts linked to their home loan where the balance is used to reduce the interest charged by offsetting it against the loan principal. According to the Australian Prudential Regulation Authority, there is currently more than $300 billion in cash parked in mortgage offset accounts.
Over a long period of time, such as a 25-year home loan, mortgage holders could potentially do better financially by turning their accrued savings into investments.
Past performance is never an indicator of future performance. Share market returns are inherently volatile.
It’s also important to note that capital gains on investments are generally taxable once they are realised, so it is prudent to consider your personal financial and tax circumstances.
But it should also be noted that mortgage interest rates are also subject to change over time, with multiple rate rises and falls likely to occur over the average term of a loan.
These changes will ultimately impact monthly repayments and interest charges, either positively or negatively, over time.
Notes:
Mortgage calculations conducted using ASIC’s Moneysmart mortgage calculator. Mortgage calculator – Moneysmart.gov.au
Investment calculations conducted using the Vanguard Digital Index Chart calculator set between 1 April 2000 and 30 April 2025. Vanguard Index Volatility Charts
Compound interest calculations conducted using ASIC’s Moneysmart compound interest calculator. Compound interest calculator – Moneysmart.gov.au
This article has been reprinted with the permission of Vanguard Investments Australia Ltd. Copyright Smart Investing
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