I have savings to pay off mortgage - but should I?

mr_rush

Don't touch the ISA.

If you are looking to use it as a pension then lock it into long term fixed rates.

Last year I locked away £54K at 5% for 5 years.

Cumulative interest is a great thing.

Well done for managing your finances so well - a very small mortgage and a healthy amount in savings is something that everyone should aspire to.

davenottingham

Thanks Mr Rush
J_B- I took out Mortgage Payment Protection so I wouldn't have to eat into my savings if I become unemployed. It costs approx £40/month with a 30 day excess and I find it does offer peace of mind in uncertain times.

Sepa74

Hi Dave, I definitely wouldn't want to eat into my Pension Pot (ISA) if I became unemployed, but would definitely consider whether you need the mortgage insurance. It is a lot per month which would really help you get rid of the mortgage more quickly!

I had mortgage insurance and was made redundant, but found it didn't really help with my peace of mind - the mortgage was a small part of my outgoings that I was still very stressed about everything else. I also got a job again pretty quickly, so only got a couple of months worth of payments out of it - so it definitely didn't have to pay out anything like what I put in.

At the same time it was obvious premiums would go up and up because of the recession.

After that experience I decided to self-insure, so I have a built up a big (six month) emergency pot which would cover me if something was to happen.

Insurance is a hard one - it's very difficult to value until you need to actually call on it. It was only when I become unemployed that I realised the mortgage insurance was probably not great value for me and I was better off self-insuring, as I realised that the real value would only be for people who do not have spare cash around and / or people who wouldn't get a job quickly again. If I was in my mid-50s, facing the prospect of forced retirement, I think I would have been very grateful for it!

Sorry, I'm rambling. I hope it makes sense!

Joe_Bloggs

I am with Sepa74 but I am unsure how to convey what may be poor value or could be absolutely ideal in extreme circumstances.

If you shell out 450 every year for a max return of just over 3250 and that you may only need to claim say is a 1000 then in my view it is a poor value deal . If you have more than enough savings to pay of your mortgage then you are virtually mortgage free and can afford to self finance your mortgage in periods of unemployment.
J_B.

jamesd

davenottingham wrote: »

I have ISA savings of approx. £46,000. This is my 'pension' fund as I do not contribute to a pension

You're using cash ISA and savings accounts. Those are unsuitable for retirement investing because the interest rates are too low. Long term expectation from investments is more like 7% plus inflation even if you stick to the UK markets, and you shouldn't. You aren't going to get anything close to that from savings accounts, matching or barely beating inflation is the effective limit for most savings.

Time to start gradually switching into a stocks and shares ISA and using investments to do more serious retirement investing.

Even if you stuck to just income-producing investments you can expect to get 5-6% of interest or distributions from investments within an ISA, without difficulty. If you were to use preference shares you can get 7-9%. All with capital value variations up and down, as usual with investments.

Don't be tempted by arguments about paying off the mortgage then saving. That throws away years of compound growth at a rate higher than the mortgage interest rate and it'll be very hard to make up for those lost years.

Even if you weren't interested in doing that and have an extremely low risk tolerance it simply doesn't make sense to pay off a mortgage when the mortgage interest rate is less than the interest rate you're getting on savings. That'd just be guaranteed throwing away of money.

Sepa74 is right that there can be benefits to a pension but there's plenty of time to do that when you're in a job where the employer will pay something. The big deal is getting investing, not using savings accounts. Whether that's in an ISA or pension doesn't matter so much.

I could also clear my mortgage at any time but I'm not irresponsible enough to do it and compromise my retirement planning by making myself poorer long term.

davenottingham wrote: »

I took out Mortgage Payment Protection so I wouldn't have to eat into my savings if I become unemployed. It costs approx £40/month with a 30 day excess and I find it does offer peace of mind in uncertain times.

Too much short term thinking there. You have ample savings for the short term. You should instead be looking into Permanent Health Insurance (PHI) that will pay out until state pension age if sickness prevents you from working again. It's more expensive but you get 20-30 years of payouts and you're not yet in a position to cover yourself for that long.

It's good that you've built up lots of savings but you've persevered with them long after you should have switched to using investments for a substantial part of the money. Other than emergency money, savings are for the short term things, not long term. Or for those who are extremely risk-averse and don't mind choosing to make themselves worse off long term to cater to that low risk tolerance.

I am now in a position to live without means tested benefits if I stopped working, though I'm still increasing the safety margin and income level. To do this it's vital to have substantial non-pension investments because you can't touch the pension until you're 55. As you get closer to 55 it becomes possible to switch some money into the pension alternative, though with some care because the GAD limit still caps the income level you can get from a pension.

Overall you've demonstrated lots of commitment but too much short term thinking and have been consistently neglecting half of your ISA allowance. Time to refocus more seriously on long term planning for retirement and early retirement, as well as longer term adverse contingencies. And to use appropriate investments for that long term provision.

davenottingham

5 years ago I wouldn't have taken out MPI. However the sector in which I work has been hit hard by unemployment (as many other sectors). So a £420 outlay per year for a max return of £11,000 (12 month payout minus 30 day excess) is the 'rose-tinted' view. I could also, as suggested, use savings to cover this.

James d- thanks for your input. I have never really looked into S&S ISA's and only have a limited, probably naive, view on them: you could get a very good return long-term, but conversely you may not, and a small part of your investment contributes to managment 'fees'
I wouldn't know where to start re. how much to invest into which S&S ISA's (there are probably many threads on here though).

Should I therefore be looking to invest in S&S ISA instead of Cash ISA's for my 'Pension' savings, or split contributions into both Cash ISA's and S&S' ISA's?

Sepa74

Hi Dave,

You are really starting to get into an area of discussion that is probably best had with an Independent Finance Advisor.

You can have it here, but what you won't get is a holistic view of your financial affairs, and that is really what you need when you start thinking about pensions.

I have a complete financial review every 5 years or so, just to be sure I'm on track. My IFA is an 'ethical' one, so he always sends me a questionnaire asking what ethics I would like my investments to have, and last time I did this, we did it on the agreement that I would actually pay him, rather than have him rely on commission.

Because I am self employed, I do have Income Replacement Insurance, and my IFA thinks it's very expensive! However I appreciate the peace of mind, and he has suggested an approach whereby as I get older I reduce the duration of the cover to match the point at which I would be able to retire. I would never have thought to do that by myself.

Like I said, I find it really helpful to have someone take an independent view of my finances every 5 years or so.

osian

We did do the same as what you are suggesting at 31 and 32. The money was not tied up in ISA's though and we were paying more out on the mortgage than we could have gained in savings interest. We had between £15-20K left over in ISA accounts after we paid off the mortgage, which we felt was enough for a buffer in an emergency.

Would we do it again? Yes. It has worked out quite well for us. That was just over 4 years ago and we have recouped our savings that we paid out on the mortgage, plus a little bit more (50% ish). My husband has also increased his pension payments to 30% as we don't 'need' so much money every month.

Perhaps sit down and do some sums - Mortgage interest v's Savings interest - How many years it will take you to get back to your current position - Whether you will lose out by having to pay early repayment charges and the like etc.

Whatever you do - you know that you have enough money in savings to cover your mortgage (plus extra) if the S**t hits the fan, so whatever you do with it, you're in a pretty good position.

jamesd

Historically it's taken no more than 18 years for there to be a 99%+ chance that share-based investments would beat cash. By ten years the chance has been 90%. That is, even at the worst possible buying times, it took no more than that long, most times it was much less. By the time the holding period reaches five years the chances of share-based investments beating cash are already very high. For regular investing you get an average of lots of different periods so you get much closer to the short end of the range than the long one.

Year by year the results differ hugely. Anything from 90+% up to 50% down for the UK market. And 20% either way every few years, as routine movements. Part of investing is recognising this and becoming comfortable with it or managing how much the movement is based on how much you can tolerate - your risk tolerance. At the moment prices are in the 20% down sort of level and more is possible, making it in general a fairly good buying time, though it might get better.

That's shares. There are also corporate and government bonds. Those tend to have capital value variations in the 10-15% range. At the moment the highest quality ones are at very high prices and aren't very good value for money.

What fees are you paying for the cash ISA and savings accounts? You don't know because there's no requirement to tell you for those. If using funds you have to pay someone to do the management work, just a price that has to be paid. Lots of noise about fees but don't lose track of the most important fact: the investment returns are quoted after investment manager fees have been deducted.

To get an idea of how this works, take a look at the Barclays Capital Equity Gilt Study 2011. Look at the page numbers at the bottom and go to page 93. Observe how the real (means after inflation) returns differ in the charts at the bottom of the page. Notice lots of variation year by year. Now look at the horizontal bars in Figure 7 and observe how the variation drops greatly as the holding time increases, from almost -60% to +100% for one year is cut to more like -5% to +20% over ten years.

Now move on to page 94 and Figure 8 to see what happens as the number of years increases and observe the way the chance of bearing cash increases over time. All this is for lump sums, for regular investing you get a mixture of periods and it gets to the long term beating cash result faster.

There is much discussion here about investing. If not comfortable and if you don't want to learn you might try visiting unbiased.co.uk to talk with a few IFAs and perhaps pay one to set things up for you. You'll pay but can expect to recover the cost in a year or two through better performance compared to what you're doing now. Can expect doesn't mean a guarantee though - see those charts for the way things vary.

If you had experience now is a good time to be shifting into investments. Also a good time with IFA help. Without either it's better to start with regular investing using your whole ISA allowance for S&S ISA investing and to gradually move all but about £20,000 of what you have now into investments over say the next two years. The next two years, gradually and regularly, so you don't buy all of the investments just before another drop, which could happen. It'd probably scare you too much as a beginner if that happened with it all. You get used to it after a while...

You have more than sufficient cash, little point in adding more, better to gradually reduce it to your long term cash need and that's far less than you have now. S&S ISA investments can be sold at any time if necessary, though there are good and bad times to do that.

If you wanted to switch £50,000 today the sort of thing that you might consider is:

£15000 Vanguard LifeStrategy 60% Equity, accumulation units
£25000 Vanguard FTSE Developed World ex-UK Equity Index, accumulation units (ex means excluding)
£5000 Aberdeen Emerging Markets*
£5000 First State Global Emerging Markets Leaders

The UK is about 8% of the global market so this is deliberately quite global to get closer to the natural mixture. The Developed World fund doesn't include emerging markets.

I don't recommend so much at the moment, too much chance of it scaring you. Half plus regular investing would be more sensible to reduce the fright factor. Fright matters, markets are uncomfortable at the moment. That means good buying times but low comfort levels and the chance of more drops later before recovery. So not at all comfortable for newcomers to investing, even if they can look at the pictures and see the trends longer term.

If your need switched to income production you'd instead look at lists of funds sorted by yield (either interest or distributions/dividends). Some of the better known and respected ones there include:

7.18% Artemis High Income
6.64% Newton Higher Income
6.59% Invesco Perpetual Monthly Income Plus
3.99% Invesco Perpetual High Income

And you might sensibly end up with a blend producing 5-6% tax free income, including some from savings accounts. Perhaps £3250-£3900 a year. Note that capital values vary, as do income levels. Also note that I've linked to income versions, if looking for total investment return (capital plus income) click on the Total Return button to see the combination and get results more comparable to the earlier funds.

When the income potential matches the income you need to live on you're much more financially secure but it'll take a while for you to get there, if you even want to try, most people don't, though I did. When it can do it with gradual reduction in capital so you don't run out before the state pensions start is an easier target that gets easier as you get older and have fewer years to pay out for.

Since you know that your particular part of the job market is more risky then keeping the MPPI seems OK but if you see an IFA ask about PHI and you really should get that long term protection if you can afford it. The cost can be adjusted by setting the level of cover low, say half of your income instead of two thirds.

There's one really good thing about your position. Unlike someone who's been regularly overpaying their mortgage and who has low savings but reduced mortgage, you can more easily appreciate the flexibility that having the money instead offers, in terms of protection, general security and flexibility.

The funds I've mentioned are just examples to illustrate the basics of how you can construct mixtures. They are all decent to good choices for various objectives but there's huge range for alternatives to be used. I've used trackers rather than managed funds where sensible because you probably don't yet know enough about how to select managed funds even if you like that type.

*This fund is technically soft closed meaning full commissions would be paid for purchasing it but that does not apply at the place I've linked to.

davenottingham

jamesd- thanks for the detailed response- I've certainly learnt a few things.
Looks like a visit to an IFA is recommended.
I'll also look at the merits of a longer term Income Replacement Insurance, rather than the a 12 month policy.