Save or pay-off mortgage question

rogermhunt

I keep having problems with the maths on this!!

I have £92K outstanding on an interest-only mortgage.
Monthly repayments are approx £99.
Term expires in December 2018.
Interest rate is 1.29% tracker.
No early redemption fees.

I have taken redundancy a year ago and also accessed taken my two pensions early. As things currently stand, I do not plan to return to full time work, but may seek some part-time work to bring in a bit of extra cash (e.g. £100 per week).

My pensions come to £1100 per month.

Because I took lump sums from two pensions and I have recently received an estate legacy, I have a large amount of savings. An endowment policy is about to mature (25% below what was expected!) in February, giving me more money.

My savings currently achieve the following:
1. Approx £25K in a 3% ISA with Halifax
2. Approx £140K in a 2.8% (gross) online saver

So, the way I figure it is that because the savings rates are better than the mortgage interest rate, then I'm better of keeping the money in savings until such time as the rates come down (which they will because the bonus will expire in April and June respectively in 2013).

However, the thing that keeps me going round in circles is the issue of inflation (currently 2.7%?) and I keep getting the calculations wrong I think.

So, I'd be grateful if anyone can suggest whether I may as well pay-off the £92K mortgage now (and therefore avoid approx £7,194 in monthly repayments over the next 6 years, assuming tracker rate remains the same), or leave my money in savings to gain interest, even taking inflation into account.

I'm sorry, I just can't figure this one out and so advice would be very welcome.

mulronie

rogermhunt wrote: »

So, the way I figure it is that because the savings rates are better than the mortgage interest rate, then I'm better of keeping the money in savings until such time as the rates come down (which they will because the bonus will expire in April and June respectively in 2013).

However, the thing that keeps me going round in circles is the issue of inflation (currently 2.7%?) and I keep getting the calculations wrong I think.

Spot on - as long as your NET rate of interest on your lowest-interest savings is higher than your mortgage interest rate, you are financially better off not to overpay. Your net rate on your online saver is 2.24% (2.8%, less 20% for tax), which is currently higher than your mortgage rate.

Inflation is a red-herring on the £92k when making the calculations, as while every £1 of your savings is losing value due to inflation, so is every £1 of your debts.

bowlhead99

Bottom line, you owe 92k and the lender will want it back with less than 1.3% per year on top, the longer you leave it the more pounds they will want back.

You also have a cash balance of at least 92k which the bank will give you back with more than 1.3% per year (you pay tax but still get more than 1.3% net), the longer you leave it the more pounds of interest you will get back.

This means that every month at the moment, you are making money. For every £1000 that you keep on deposit instead of paying off the loan, you make £28, or £23 after tax. And you pay 13 of interest expense. You are making a tenner a month profit after taxes, which you could not make if you paid back your borrowings.

Mulroney is right, inflation is a red herring. Your tenner a month free money will buy you twelve cinema tickets a year or a couple of loaves of bread a week. In 2018, with the effects of inflation, that same fixed amount of profit might only buy 10 cinema tickets a year or one loaf of bread a week.

If you pay off the loan and give up your profit, you will have zero cinema tickets and no bread.

A few things:

- Your mortgage rates might rise in future and your savings rate might increase or the tax rate on it might increase. If the savings generate less than the mortgage interest you can consider paying them off.

- Even if it's borderline or perhaps the mortgage rate is slightly higher than the savings interest, you might not want to pay it all off - remember if you have some unexpected emergency need, it is good to have a stash of cash in the bank. There is some intrinsic value in having cash available (e.g. to pay the kidnapper's ransom for your son, replace the car you crashed the day after the insurance ran out, or to help out a friend in need, whatever), rather than have to go to the bank as an unemployed person and ask for a loan or a remortgage before you can do the above.

- If you do pay off some or all of the mortgage, don't do it with the ISA money, do it with the online saver money. The goal is to have more money in a tax-free wrapper, not less

- On the inflation concern you have, you are right that the value of your cash is eroded by inflation because nobody owes you a living, you're unlikely to outperform inflation if you are not taking any risk. For your excess cash beyond the 92k you need to pay off the mortgage and whatever else you plan to spend over the next 5 to 10 years, you could consider investing it in investments rather than cash. Investments will go up and down from month to month but over the long term can provide a return which exceeds the cash return and exceeds inflation.

mw2655

you might want to have only £85k with any one financial institution and not all £140k in one place?

TheLastMongoose

I probably sound crazy but just remember your saving are only as secure as the bank that holds them. If the global economy starts going downhill again it might be worth paying off the mortgage for peace of mind so you know whatever happens, you will still have a bed to sleep in.