savings vs. mortgage overpayment

boglehead

I have spent a lot of time reading this forum - what an amazing source of inspiration, education and motivation. Thank you all for that.

I have been doing a lot of thinking lately about my retirement planning and taking a hard look at my financial situation for the future (i suspect the arrival of my first child has been the trigger point to all that...) and i am left with an underlying question which i am struggling to answer: should i consider making mortgage overpayments and try to reduce my exposure to interest rate movement, or given how unrealistic being mortgage free really is in my situation, should i save as much as possible on the side to diversify my net worth participation.

Here are the facts about my situation:
- 35 yr old planning to retire around 60y/o
- 75% of net worth tied up in real estate (principal residence in london)
- 750k mortgage with 23yrs left on it... current rate 1.9% for another 18months
- company pension 6% personal contribution, matched by employer (i anticipate reaching the lifetime allowance within 15yrs... so no incentive to invest more, and employer doesnt match more than 6% anyway)
- i also save the full share and stock ISA allwance everyyear for both me and my partner (£23k) and plan to do so until i retire
- the mortgage is my biggest monthly expense 60% of my monthly outflows ex savings
- i have an emergency funds worth 12months of expense, including mortgage payment

My wife and i have between 1.5 and 2k left a month to save - we are wondering whether we should use that to overpay the mortgage, which will hardly make a dent in what we still owe, and given how much of our net worth is tied to RE, my approach so far has been to try to limit our exposure by investing it on a taxable account

Do you think it is sensible?


Thanks a lot for your guidance

Linton

Normally I would probably say dont overpay your mortgage, at least at the moment. However in your case there are a number of factors that push the decision the other way in my view...

1) You are heavily over -"invested" in your London property. Would a major rise in interest rates in the next few years be a problem?
2) You are already using much of the standard tax protection options. Is your partner making a significant pension provision?
3) You look to be well on your way to having a large amount of money available for retirement at 60 and may well be able to consider retiring earlier.

atush

I have to say, Linton is spot on (which is not unusual lol).

Normally I too would say invest over overpaying mtg at 1.9% BUT, as said your 750K debt could spiral so much higher if rates went up.

So, look at OH's pension and split savings after boosting partners pension between overpayment and other unwrapped equity savings. With a look towards paying down mtg even more with unwrapped funds if rates rise

boglehead

Linton, my ltv on the house is about 50% so even if the market corrected, it would not be the end of the world. I still intend to stay in that house for a good 10/15 yrs, by then the market will have recovered.
Also, realistically, making overpayment over the next 3yrs (interest likely to be capped at that point, as nobody inc treasury can afford a base rate greater than 2/3%) wouldnt reduce my mortgage significantly... 100k max. My monthly payment wouldnt be drastically cheaper with still 650k left on it...
What worries me about overpayment is that i am afraid of putting all my eggs in the same basket - keep in mind 75% of my net worth is tied up in real estate... Overpaying would make it even worse.
My partner is also maxing her pension contribution to whatever her employer matches. Projections here again is that she will max out the lifetime allowance by the time she retires.
Although i like the idea of a pension tax wrapper, i know what governments do when they need money (check hungary, poland and france tax shelterred investment vehicles... They cropped the benefits without warning). So my approach here is to contribute whatever our companies match, the rest goes into isa, the rest is directly accessible in taxable account.
Those taxable accounts are passively invested in index linked etf, with very low turnover... Hence limited CGT

Do you still think overpayment is still worth it? ie digging in the sahara with a tea spoon?

boglehead

atush wrote: »

I have to say, Linton is spot on (which is not unusual lol).

Normally I too would say invest over overpaying mtg at 1.9% BUT, as said your 750K debt could spiral so much higher if rates went up.

So, look at OH's pension and split savings after boosting partners pension between overpayment and other unwrapped equity savings. With a look towards paying down mtg even more with unwrapped funds if rates rise

Fair point... If rate goes back up to 2%, that mortgage prob will be around 3.5%... That an extra £800 a month of interest charge...
If i was to pay it down by 100k by the time rates go back up to 2% (big if), that interest charge increase would still be 500/600 extra a month...
In these conditions, doesnt 100k feel better on a retirement/investment account instead of used up in what is still a big mtg?
Not sure what to think anymore...

guymo

If I have read everything correctly, you and your wife have £2k / month to put towards the ISAs and a further £1.5-2k to save "somewhere".

In these circumstances you have your mortgage payments so easily covered even in the event of interest rate rises that you would be crazy to be concerned about that. Paying off a loan that is currently racking up interest at 1.8% makes no sense when you can easily earn better than 1.8% on the money elsewhere.

Keep some cash around for liquidity, invest in some equities, and for heaven's sake try to enjoy the fact that you are a new parent and are very well off.

boglehead

guymo wrote: »

Keep some cash around for liquidity, invest in some equities, and for heaven's sake try to enjoy the fact that you are a new parent and are very well off.

Good advice Guymo... and trust me the wife is doing good on that front :-) I am the one who worries too much. This new birth really turned a "provider" switch on inside me, and I am worrying about making sure our future is secure all the time - borderline stingy at times !!

atush

Your OH's pension is she just maxing her employers contribs or does she put in more? What is her rate of tax?

if employer pays just 5% matched that is only 10% and I would more in unmatched. Esp if she pays HRT.

nrsql

What are the conditions on overpaying your mortgage?
If it is flexible then I wouldn't pay it off but keep money available so that you can.
If there are penalties for paying off large amounts then you are exposed to any rate increases and I would think about reducing it. I suspect rates will start going up in the next couple of years but probably not by a lot initially.
I look at what would happen if my mortgages went up to 6% (under 1.5% at the moment).

boglehead

atush wrote: »

Your OH's pension is she just maxing her employers contribs or does she put in more? What is her rate of tax?

if employer pays just 5% matched that is only 10% and I would more in unmatched. Esp if she pays HRT.

Atush, she is contributing 8% and the company also adds 8%. Her marginal tax rate is 40%.
I am not a big fan of pension, cause I am pretty sure the government will change the law around pension (either decrease the life time allowance, or reduce the lump sum amount or something else...). The bottom line is that the pension tax benefits are going to get worse, not better. I don't want to wake up in 20yrs, to find out that I should have not put that much in my pension pot...
I think that putting in what the company matching is fairly safe, as you only give up £6 of net salary to get £20 in the pension - anything beyond that is risky. Especially since we both will hit the lifetime allowance before our retirement age.

boglehead

nrsql wrote: »

What are the conditions on overpaying your mortgage?
If it is flexible then I wouldn't pay it off but keep money available so that you can.
If there are penalties for paying off large amounts then you are exposed to any rate increases and I would think about reducing it. I suspect rates will start going up in the next couple of years but probably not by a lot initially.
I look at what would happen if my mortgages went up to 6% (under 1.5% at the moment).

I just do not see how the rate can go back up to 6% - the british government cannot afford the consequence of this, economically, and politically and here is why...

- with the national debt at £1.3T the UK cannot afford to refinance itself at 4-4.5% it would only compound the debt & deficit issue and put this country in a state of virtual bankruptcy.

- 40% of the population has a mortgage... a 450bps increase would lead to an uncontrollable amount of loan defaults, as 99% of those mortgages are variable. This would lead to 1) potential bank default like we've never seen before 2) government bail-out would need to happen, and only compounding the debt issue mentioned above

- Besides housing, the inflation risk is minimal for the next 5 years... we might actually be closer to a deflation risk, so the BOE would have no incentive to raise the rates.

That's just my opinion those... I can see how the bank rate could get back to 1.5% within the next 3 or 4 years though.