Paying off your mortgage vs investing
If you’re struggling to decide where to put your money, we’re here to help you examine the pros and cons to both investing and paying off your mortgage.
After a long period of ultra-low interest rates, many of us are now facing a dilemma: do I invest and make the most of my money, or do I pay off my mortgage?
With thousands of us grappling with interest rate rises, many are desperately overpaying before they move to higher fixed mortgage deals.
So, with rising interest rates, which should we prioritise – investments or mortgage payments? Which will make us better off in the long run?
Is it better to pay off my mortgage or invest?
Paying off debt is a major financial goal for most of us. Whether you have a student loan, a car loan, or a mortgage, at some point in all our lives we are faced with the prospect of paying off debt.
Clearing a mortgage early, especially when this debt can hang around for decades, can make a significant impact on your income. Consider how the rise in interest rates mean you’ll pay more on interest with a mortgage over the long term
The decision ultimately depends on your financial circumstances. Maybe you have a small mortgage less affected by rises in interest rates, or secured a good mortgage rate, or you are close to retirement and have some spare cash.
Windfalls such as a bonus or inheritance can offer the opportunity to either split the cash between mortgage repayment and investment. You could make mortgage overpayments, though remember you may pay an early repayment penalty for certain amounts. Or you could pay up to £20,000 a year in a tax-efficient Stocks and Shares ISA.
Before you start, there are some financial health ‘best practice’ questions to think about before you commit a large amount of money to a mortgage or an investment:
- Do you have any debts? Debt repayment, aside from mortgages, can often carry a high interest rate. It's generally best to focus on reducing your debts before deciding to invest.
- Do you have a rainy-day fund? Having savings can protect you against unexpected costs. Once you've got this safety net in place, you'll be in a better place to invest your money.
- Do you have childcare costs? Make sure you’ve accounted for costs such as nursery, school or university fees and costs, or any Junior ISA or Junior SIPP payments.
- Can you commit to investing over 5 years or more? Over the short term the stock market can be unforgiving. By investing for longer you may be able to ride out anything from general market volatility to larger shocks to the market.
- Are you paying into a pension? Perhaps the most important question, do you have a plan for retirement? Before putting money into your home or the stock market, ensure you’ve secured a plan for your future.
Paying off your mortgage: pros and cons
What are the benefits of paying off your mortgage early?
- Paying off your mortgage early means you’ll free up a significant slice of your income to use on other priorities such as topping up your pension, making home improvements or planning the holiday of a lifetime.
- The longer you have a mortgage, the more the interest builds up. Yet the more you pay off, the less interest rates impact your loan.
- Overpaying your mortgage also reduces your loan-to-value (LTV). That is the percentage you owe compared to the value of your home. If your LTV is low, you’ll have access to lower interest rates when remortgaging. This makes it easier to reduce your core loan further or reduce your term.
The potential disadvantages to paying off your mortgage
- If you have other debts such as credit cards, personal loans, or car finance, then focusing on your mortgage may mean you’ll rack up higher charges on those unsecured debts. Removing high interest debts is generally the first thing you should do.
- Mortgages often have early repayment charges. This means the bank will only let you overpay a certain amount every year before they start charging you. The early repayment charges will be listed in your mortgage agreement.
- Property is an ‘illiquid asset’ – it can’t be converted to cash easily so make sure you maintain a healthy cash reserve for unexpected costs.
Investing your money: pros and cons
What are the benefits of investing your money?
- Investing in the stock market can mean your money grows at a faster rate than inflation.
- If you make the right investment at the right time, you can see quick returns.
- If you’re investing in a Self-Invested Personal Pension (SIPP), your employer may be able to match your contributions, this along with pension tax relief means your pension pot grows at a greater rate.
- If you invest in an ISA or a SIPP, any growth in your investments is free of income tax, capital gains tax and dividend tax.
The potential disadvantages of investing your money
- Investing is risky. Investments can fall as well as rise in value. Nobody can predict the performance of the market, so you should only invest what you’re willing to lose.
- Investment platforms will charge platform fees, funds will have individual charges, investing overseas might involve FX fees and so on. Make sure you understand the costs and charges involved with investing.
- Investing is generally a long-term strategy. If you are investing for the first time, are you able to hold onto those investments for 5, 10 years or more?
- Investing involves a lot of research and an understanding of your tolerance to risk, although you can mitigate this using an investment broker or investing in a Managed ISA.
What do the numbers say?
Broadly speaking, if the stock market grows more than mortgage interest rates then you could be better off concentrating on boosting your pension saving, whereas if mortgage interest rates outstrip investment performance, you might benefit more from paying off your mortgage first and then concentrating on boosting your pension. If mortgage rates and investment performance are the same, then there’s not much in it.
Of course, in reality interest rates don’t remain static, and you may therefore decide to prioritise investing or overpaying your mortgage at different times.
Victoria Scholar, Head of Investment at interactive investor, researched three scenarios where investors face either low interest rates and high growth, high interest rates and low growth, and equal rates and growth. Here are the results:
Scenario 1 : interest rates 6%, investment growth 5%
- Overpaying a 25-year £200,000 mortgage with an average interest rate of 6% by £200 a month means paying off your mortgage six years early.
- Investing the previous monthly mortgage payment of £1,288 per month (plus 20% tax relief) into a pension for the next six years amounts to £165,901 in additional pension investment, assuming 5% investment growth.
- Assuming an investment return of 5% per year, choosing to invest the extra £200 a month, plus the tax relief, into a pension over the same period would result in extra pension wealth of £148,877- £17,000 less than the previous scenario.
Scenario 2 : interest rates 5%, investment growth 6%
- If we rerun the example above with interest rates of 5% and investment growth of 6%, paying into the pension first, leaving the investments longer to grow, wins out in terms of returns.
- In this scenario, overpaying the mortgage by £200 per month for the rest of the mortgage term still means the debt will be paid off six years early. Investing the previous monthly mortgage payment of £1,169 per month (plus tax relief) into a pension for the next six years amounts to £152,758 in additional pension investment.
- But putting the additional £200 (plus tax relief) into a pension for 25 years would result in extra pension wealth of £173,248 – around £20,000 higher than the previous scenario.
Scenario 3: 6% interest rates and 6% investment growth
- If we rerun the same example with interest rates of 6% and investment growth of 6%, overpaying your mortgage or pension is roughly equal from a returns perspective.
- In this scenario, overpaying the mortgage by £200 a month (again, resulting in the debt being paid off six years early) and then investing the previous mortgage payment of £1,288 per month (plus tax relief) into a pension for the next six years could result in £171,455 additional pension investment.
- If instead, you put the additional £200 (plus tax relief) into the pension for 20 years, you could end up with extra pension wealth of £173,248 – around £2,000 higher than option 1.
Extra pension wealth after 25 years | ||||
6% interest rates, 5% investment growth | 6% interest rates, 6% investment growth | 5% interest rates, 6% investment growth | ||
Option 1 | Overpaying mortgage first and then pension (with tax relief) | £165,901 | £171,455 | £152,758 |
Option 2 | Paying into pension first | £148,877 | £173,248 | £173,248 |
Option 3 | Overpaying mortgage first and then pension (no tax relief) | £132,720 | £137,164 | £122,224 |
Difference between options 1 & 2 | £17,024 | £-1,793 | £-20,490 | |
Assumptions: 25-year repayment mortgage, 20% tax relief, Option 1,2 & 3 - overpayment into mortgage or pension of £200 per month, Option 1 & 3 - once mortgage is paid off, divert mortgage payment into pension, returns net of investment fees.
Broadly speaking, if returns from the stock market are higher than mortgage interest rates, then you’re better off investing. Whereas if the mortgage interest rates are higher than what you’d get from the stock market, you’re better off down paying your mortgage.
Deciding if overpaying your mortgage or investing is right for you
There are plenty of online tools that let you calculate the saving you’d make if you overpaid on your mortgage. For example, if you have a mortgage of £200,000 on an interest rate of 4.5% over 25 years, then overpaying by £500 a month would save you £63,820 in interest alone.
But cutting your interest bill might not be the only reason you want to pay off your mortgage. You may simply wish to reduce your monthly household expenditure to cope with rising bills. Or you may be approaching retirement and not want to continue paying a hefty mortgage out of your pension. If you are wondering if you have enough money set aside for your retirement, check out our Pension Calculator.
Estimating how much an investment might grow over the same 25-year period is near impossible given the fluctuations in the market. Investments may grow by more than £63,820 over 25 years if your annual growth is over a certain percentage, but relying on that is a risky strategy unless you can commit to contributing a regular amount and manage your investments very closely.
Make sure you set clear goals. What’s your risk tolerance? Do you want to reduce debt, increase your pension, or create a passive income from investments?
Research is the key. And if you’re not sure, please seek advice from an independent financial adviser.
Learn more about investing
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