Should you pay off your home loan or invest before retirement?
Should you invest extra cash or use it to settle your home loan? The answer becomes increasingly important as retirement approaches, when debt can place significant pressure on your monthly cash flow.
Imagine George and Thembi are 58 years old and plan to retire at 65. They have done reasonably well financially. They have retirement investments, their children are mostly independent, and they earn good incomes.
But they still owe R1.2 million on their home loan.
They suddenly have an extra R10 000 per month and face a common question: should they use it to pay off their bond before retirement, or invest it and give the money seven years to grow?
At first, this sounds like a simple maths problem. Compare the home loan interest rate with the expected investment return and choose whichever is higher.
I don’t think it is that simple.
Your investment return is uncertain. The interest you save by reducing your bond is relatively predictable. Then there is tax, liquidity, your age, behaviour, investment horizon and, particularly as retirement approaches, cash flow.
Start with the interest rate
Suppose George and Thembi are paying 10% interest on their home loan and receive a R100 000 bonus.
If they put it into their bond, they immediately reduce the amount on which the bank charges interest. In simple terms, they are effectively receiving a return roughly equal to the interest they no longer have to pay.
If their home loan costs 10%, an alternative investment therefore needs to compete with that after considering fees, tax and risk.
A diversified growth portfolio could potentially produce a higher return over time. But “potentially” is important.
Markets could rise strongly. They could disappoint. They could also fall significantly. You are comparing a relatively certain saving with a potentially higher, but uncertain, investment return.
Time changes the equation
Now imagine George and Thembi were 35 rather than 58. With another 25 or 30 years to invest, they have considerable time for compounding and, importantly, time to recover from poor markets.
At 58, with only seven years until retirement, the calculation changes. Imagine they invest aggressively with the intention of settling their bond at retirement, only for markets to fall substantially when George is 64.
They are suddenly one year from retirement; the bond remains, and the investment they planned to use has fallen in value.
The shorter your investment horizon, the less room you have for things to go wrong.
What happens when your salary stops?
For me, this is one of the most important considerations. Suppose George and Thembi reach retirement with a bond repayment of R20 000 per month. That is R240 000 a year.
While working, it comes from their salaries. In retirement, it may need to come from their investment portfolio.
If their lifestyle costs R60 000 per month, they now need R80 000 because of the bond.
That can materially affect the sustainability of their retirement plan. The better question may therefore be: how much additional income will my retirement portfolio need to produce because I still have this debt?
Reducing debt can lower the amount you need to withdraw from investments and provide greater flexibility during difficult markets.
Behaviour matters
There is another question: will you actually invest the money? It is easy to calculate what R10 000 invested every month for seven years could become. But that only works if the money is actually invested.
December arrives. There is a holiday. Then a new car. A renovation. A child needs financial help.
Slowly, that R10 000 disappears into lifestyle spending. Seven years later, the bond remains and the investment portfolio you were supposedly building doesn’t exist.
Personal finance doesn’t happen on a spreadsheet. It happens in your behaviour.
Why not do both?
The debate is often framed as: “Should I pay off my bond or invest?”
Who says it has to be one or the other? George and Thembi could put R5 000 into their bond and R5 000 into investments. They reduce debt while continuing to build liquid, diversified wealth outside their property.
This also helps avoid becoming property rich and cash poor.
A R7 million paid-off house might look wonderful on a balance sheet, but your house doesn’t pay for groceries.
So, which is better?
For someone who is 35, with a long investment horizon, manageable debt, an emergency fund and strong investment discipline, I wouldn’t necessarily rush to pay off the house at the expense of investing.
But as retirement gets closer, my thinking changes.
I want a clear answer to one question: what happens to your home loan when your salary stops? The closer you get to retirement, the more weight I generally give to reducing significant debt.
And if the numbers between investing and paying off the bond are relatively close, I wouldn’t obsess about finding the mathematically perfect answer.
I might do both. We don’t know exactly what markets will return, where interest rates will go or what life will throw at us.
What we can do is build a financial plan that gives us options. And ultimately, that is what wealth should give you: options.
Comments