Question re Martins Savings Article

alunp

From Martins article

"Where to start saving

Paradoxically, don’t start saving with a savings account. First pay off your debts."

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My questions on this

1) Is a mortgage considered a debt for this purpose.

2) If so, how do the maths of this stack up. Why is it better to pay off part of your mortgage off than save the money.

For instance, assume I get 30k that I can either pay off a part of my mortgage with, or keep the 30k and save it, why is paying off my mortgage better.

I understand that the interest rate for debts is higher than for savings. But to pay off the debt I'd lose the 30k.

Although costing me a few % more in interest to keep the debt and save the money, I'd finish any given time period with the 30k still intact. I'd have just increased it by less than I'd saved.

Ultimately, given that Martin is right that savings that don't beat inflation lose money lets look at this.

At 5% inflation I'd want that 30,000 to be worth 31,500 this time next year. By paying off part of my mortgage, my 30,000 will be worth 0 this time next year.

Whereas if I put it in an interest account of 5% then it'll be worth 31,500.

So I don't fully get the exact reasons why paying off part of a mortgage makes more sense than accepting a lower savings interest rate, and saving it, because in the latter circumstance I keep the 30k, and in paying off my mortgage I don't.

Can someone give me a well thought through response?

Many thanks

Al

margaretclare

Many people do NOT consider a mortgage the same as other types of debt. Yes, it's a debt, but it has 2 aspects that other debts may not have: it has the practical aspect of providing a roof over your head, which we can't live without, and also it's usually considered that a house is an appreciating value whereas e.g. a loan for a car is a depreciating value.

This idea - pay off debts before savings - is one of the simplest, and it's one that my DH managed to hammer through my head when we first got together, some 8 years ago. I was struggling to save but I still had debts, and I couldn't understand why the debts never got less - DDs bounced, you name it. You can get 4.5% on most decent savings accounts, but you're usually paying a lot more in interest on other debts, especially if it's on credit cards on which you're only paying the minimum monthly.

Leave the mortgage out of the equation. OK, some people, when they become debt-free, concentrate on paying off the mortgage more quickly. But for the present, concentrate on the other debts.

Best wishes

Margaret Clare

missile

You do not give enough info for a proper response, for example what rate your mortgage is, what other debts, income, your personal circumstances, aspirations etc etc.

In general terms, you are unlikely to get as good a rate on any investment as you pay on mortgage without high risk, so yes it makes financial sense to reduce your mortgage. However you need to maintain a cash "float" i.e. how much are you likely to need for emergencies or something else like holidays clothes Mars bars or whatever. £30K may be enough float for you but not for a.n.other, it all depends on your circumstances.

I suggest you re-read Martin's article

Patr100

I think Martin has elsewhere - maybe in his book - made the distinction about a mortgage being separate from other debts for a number of reasons.
Most people he helps on the Tv prog he concentrates on getting a better rate, even if they might have the funds to reduce or pay off early.

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Joe_Bloggs

Well said Margaretclare and all.
Interest rates on savings are generally much less than those on debts.
Interest paid on savings is taxable at rates of 0%, 10%, 20% and 40% depending on income. Often 20% is assumed when a net figure is mentioned.
So 5% on 30,000 in a deposit account gives you a net £1200 in interest. If you could to put this money inside a 5% mortgage the benefits would be £1500 in interest not paid to the lender. You can't pay tax on what was not paid. This is the equivalent of getting 6.25% gross in a taxable deposit account.

The same argument works for paying off debts with the highest interest first rather than saving beyond your normal requirements in lower rate accounts with taxable interest.
Some people think they can beat the system by have 'saving' for a 5% mini-cash ISA and then buy £1000 worth of premium bonds, whilst having a several thousands on 18% plus credit cards.

You do need some savings to manage debt without incurring banking charges and for mishaps that would otherwise result in more debt and stress.
J_B.

Hereward

alunp wrote:

From Martins article

At 5% inflation I'd want that 30,000 to be worth 31,500 this time next year. By paying off part of my mortgage, my 30,000 will be worth 0 this time next year.

Whereas if I put it in an interest account of 5% then it'll be worth 31,500.

So I don't fully get the exact reasons why paying off part of a mortgage makes more sense than accepting a lower savings interest rate, and saving it, because in the latter circumstance I keep the 30k, and in paying off my mortgage I don't.

If you use your £30k to pay off some of your mortgage you haven't lost it, what you have done is gained £30k of equity in your home. If house price inflation continues at its current pace your £30k will have increased in value by more than the standard inflation rate, and any rate that you could gain keeping it as cash savings. In addtion to the reduction in the amount of debt, it is possible to rebuild any cash savings from the cash that is no longer required to service your debts; howver, I would not recommend reducing your payemnts to outstanding debts if the extra payment does not clear it.

The only problem with this is that you can no longer easliy access this money: you would have to take extra borowing against, remortage or sell your home to access the £30; whereas keeping in a savings account the access is relatively straight forward.

Chrismaths

House price inflation will have no effect on the £30k. Consider example:

House value at start: £100,000
Mortgage at start: £100,000
Deposit: £30,000

If house price increases by 10%, House is worth £110,000.

If he sells the house without paying off the mortgage, he has his deposit of £30,000, and a £10,000 profit, making £40,000

If he sells the house after paying off £30,000, he will have a mortgage of £70,000 to pay off, so he still has £40,000.

The benefit to paying off your mortgage is that you don't pay interest on that amount (so there is no tax), and that mortgage rates tend to be higher than savings rates. So if you pay off £30k of a mortgage with an interest rate of 6%, you make (or save) £1,800 a year. If you had saved that at 5% and were a basic rate taxpayer, you would have earned a net £1200 in interest.

The key is to have a flexible mortgage where you can draw down on overpayments, so you can access the money if you need it.

Xbigman

This thread seems to be putting an incredably wide interpretation on the 'pay off debts before saving' philosophy. Whereas it is very wide ranging in application what this thread is responding to is really the question 'what to do with a 30k lump sum'? As already stated, more information would be required to answer that question. IE, rate on mortgage, actual interest rate on savings, non-tax payer or tax payer, how much are you prepared to risk the money, etc...

Now if we are talking general principals then you should pay off debts before saving because it gains you money. But once into the realms of mortgage rates of interest the savings can be pretty small, or even reversed where its better to save the money. The biggest factor in these circumstances is often tax. Income from savings is taxable, but the saving from paying less interest is not.

As to the question of the 30k still being there if you save it and not being there if you pay off debts. This is something of a spurious question because your financial bottom line is the same. 100k mortgage + 30 k savings is the same as 70k mortgage + 0 savings. But 70k mort + 0 savings should leave you better off at the end of each month, and therefore richer.

If the OP is uncomfortable with having no savings then maybe pay off 25k, stick 3k in an ISA and keep 2k in an instant access account for emergencies. The ISA money will be pretty close to the mortgage rate and tax free. Then put the increased income from the lower mortgage payment in that ISA each year to build up a nice tax free lump sum.

(I'll leave the pay off 'amount of mortgage' or 'term of mortgage' for another board).
Regards



X

alunp

The non mortgage debts are now all 0% and should be paid off soon.

So its all about the mortgage now really.

Al

alunp

Hereward wrote:

If you use your £30k to pay off some of your mortgage you haven't lost it, what you have done is gained £30k of equity in your home. If house price inflation continues at its current pace your £30k will have increased in value by more than the standard inflation rate, and any rate that you could gain keeping it as cash savings. In addtion to the reduction in the amount of debt, it is possible to rebuild any cash savings from the cash that is no longer required to service your debts; howver, I would not recommend reducing your payemnts to outstanding debts if the extra payment does not clear it.

The only problem with this is that you can no longer easliy access this money: you would have to take extra borowing against, remortage or sell your home to access the £30; whereas keeping in a savings account the access is relatively straight forward.

Thats the point really isn't it. I think I HAVE lost the money at that point. I can only get it back by loaning it at a %age interest rate.

Its someone else's money. All that happens is that I give away my 30k so I no longer have it, even if I become more likely to get credit in the future.

The benefit of course is that I reduce my monthly outgoings by £x, but I do so by throwing away the 30k.

I don't work or claim benefits, so any interest I earned wouldn't be taxed.

It does seem that on a monthly basis that I'm better off paying off the mortgage, but the difference monthly between the two seems minimal, and I'd still have the lump sum rather than just giving it to the building society and never being able to get it back.

alunp

Thanks for the responses.

The mortgage rate is 6.29% and fixed for the next 8 years.

All other debts are on 0% and will soon be paid off.

My wife is a taxpayer but I'm not. I believe I wouldn't pay tax because I'm allowed to earn so much untaxed per year and the interest would be under that.

So there's no tax comparison.

But if I paid off the mortgage, the interest rate would reduce and so would the monthly capital repayments.

BBC mortgage calc says i'd be 213 better off (157 of that is interest) every month.

5% of 30,000 would only bring in 125 a month.

So that's 88 a month difference, or 1,056 quid every year.

The thing I AM thinking is, in order to generate the interest on the 30k, I wouldn't be allowed to touch it anyhow so I'd have it but not really have access to it unless I wanted to further reduce its earning power anyhow.

I'm thinking that paying off the mortgage, or finding an investment that pays more than 6.29% is the way to go. But the latter is risky and the former is safe.

I can't think I'd need that big a slush fund and if I needed something I could get very cheap credit these days anyhow.

Thanks for your responses

Al