Using a pension to pay off mortgage

ExMugPunter

It looks like I am losing the (friendly) battle with the Mrs with regards to moving house. So in order to pacify myself, feel that I have won at least a little bit, and get my head straight, any advice is welcome.

In a nutshell, we are in our late 30's and currently have a 3 bed semi which would be mortgage free in about 10 years. Now I love the fact that we have got on top of the mortgage and the low payments are allowing me to put a few 100 per month in ISA' and a Personal pension (may main pension is the TPS).

However if we moved into the Mrs' ideal house we would then be mortgaged upto about aged 64 with less, but still some, spare cash for investments. Obviously this means that the mortgage will run into an age where we could get at personal pensions. The TFLS inparticular. So rather than overpaying the mortgage, am I right in thinking that we would be better off paying extra into a pension, getting the tax uplift and then using this to pay off the mortgage early when old enough to access it?

Seeing the 'total interest paid' on the mortgage estimate is doing my head in. I have tried to get on the right side of compound interest, but this feels like a kick in the teeth!

However, by doing this, is it possible that I could be making what I initially felt was a poor financial decision, into quite a shrewd one (thanks to the tax uplift)?

Sorry if that is a bit long winded!

greenglide

Does it not all depend on what interest rates do over the next 25 years?

If interest rates stay at the current really low levels, well below the current returns on investments then anything other than making the absolute minimum payments looks daft!

However if you make long term plans on this basis and in 5 to 10 years we see a return to 1980s style interest rates you might wish you had taken a different course.

Of course the 1980s was also high inflation and huge house price inflation which cut the real cost of mortgages hugely.

Could you not compromise on a property that has some but not all of the nicer ones?

At least you could downsize in 25 years time!

232607

Well just to share my experience...I was recently overpaying the mortgage by £300 PM to pay it off early until I realised how foolish this was. My company operates salary sacrifice meaning for every £1 that goes in to my pension (over the comany's max contribution) I only lose £0.68 in net pay.
I've now reduce the mortgage back down to the norm and put the extra £300 net pay in to the pension.
This means that £441 goes in (47% uplift). A no brainier really. Of coarse when I draw the money out I'd pay an effective rate of tax of 15% meaning the £0.68 is really uplifted to £0.85 or a 25% uplift. I worked out that when the mortgage needs to be paid I can pay it from the pension & the pot would still be £30K higher than if I hadn't done this.
This also assumes low investment returns of 2.25% that match the mortgage rate. In truth this is likely to be higher meaning the £30K will be higher.

The only thing I'd caution you on is you're younger than me thus you're locking the money down for longer till you can get hold of it. I'm only 7 years off reaching 55.
If you're ok with this I'd say it's a good plan but "crunch" your own numbers off before you do it.

Regards

jamesd

Assuming anything close to historic investment performance you can expect to be huge winners from using the pension approach. Even more so if either of you is a higher rate tax payer or you have salary sacrifice pensions available.

If you compare investing to the mortgage overpaying you can use a regular savings calculator. Put in 7.5% as the interest rate to get approximate UK historic stock market growth rate, less about 0.5% in charges. This is not an inflation-adjusted rate because this is for mortgage repaying and the amount owed on a mortgage doesn't increase with inflation. For pension calculations use 4.5% instead to get the inflation-adjusted value.

Just compare the regular saving value to the saving from mortgage overpayment calculators and you'll see how much better investing is.

You could also consider some use of P2P investing outside a pension if desired, since rates of 9-12% are quite readily available. But maybe best to wait a bit for ISA availability and get started on the pension first for now.

Because of the investment growth typically being well above mortgage interest rates and again because of tax relief the general rule is that overpaying on a mortgage makes you poorer than you could be if you invested instead. Overpaying's advantage is certainty, making it the choice for those with very low risk tolerance. In your case you have the additional safety margin of a final salary pension scheme and its lump sum.

One exception to using the pension lump sum is typical public sector pensions, where the effective commutation rate for taking a lump sum is poor. That's also typically true for defined benefit pensions in general. Some schemes let you pay in AVCs and pay out the lump sum for the whole pension from just the AVCs, avoiding commuting any of the main pension. These are good deals if you can handle the restriction of not getting the lump sum until you take the main pension income.

You can increase the gains by increasing the mortgage term so you increase the amount that can be invested and make it closer to the ideal interest only mortgage for this sort of planning.

About 4.5 years after taking out an interest only mortgage I currently have a 25% pension lump sum value of around 92% of the mortgage balance. Low income multiple, though.

So far as the house goes, it may well be a poor financial decision to buy it but it will presumably deliver both non-financial benefits and potential capital growth that could later be exploited by downsizing around or after retirement.

Thrugelmir

ExMugPunter wrote: »

However if we moved into the Mrs' ideal house we would then be mortgaged upto about aged 64

How secure is the nature of your employment?

ExMugPunter

Thrugelmir wrote: »

How secure is the nature of your employment?

I am a Primary school teacher, so, more secure than most I guess. But the way teaching is going, who knows!

But also in our favor is the fact that my wife is currently working part-time (due to having a young family - hence her desire for a bigger house) as a Physio with the NHS .
Worse case scenario, she could pick up hours if need be. Also, a few years down the line, she will (grudgingly) go back full-time anyway. So to be honest, whilst we don't earn a fortune, we are comfortable and have scope and back up options should things go wrong.

Its not really the affordability that bothers me, its exposing myself to paying all that extra interest!! Especially when the finishing line of our current mortgage is in sight.

People think I am being too cautious and should just go for it, but I have tried to make sure we are on a sound financial footing these last few years. I don't want to jeopardise that just for a bigger and more attractively arranged pile of bricks.

PeacefulWaters

What if you edge into your fifties and decide you hate your jobs?

You really will be slamming the door shut on any early retirement choices.

adnanmanzoor

Question is how will you generate income at age 64 if you payoff your mortgage with your pension?

Dunnit

For some people the decision is easy; you keep the wife happy - there are fringe benefits.
What else are you intending doing with the money you save? If it is for private education for your children then fine, if it is for holidays and cars then fine.
At present the UK is under building by about 120k houses per annum so there is not a lot of risk in buying.
Ignore the gross interest, your house will be a good investment. Buy a house that keeps everyone happy.
A second pension would be tying a lot of money up and as we have seen all governments appear to like changing the rules because of the impact it can have on the economy and saving habits.

bowlhead99

adnanmanzoor wrote: »

Question is how will you generate income at age 64 if you payoff your mortgage with your pension?

That's a sensible question to ask. Jamesd is right that paying off a mortgage (or mortgage interest) with a tax free lump sum - when you would have otherwise had to pay tax on all your salary if you'd had it earlier and not made pension contributions - is quite an efficient approach.

Of course, if you have already recognised that making extra pension contributions to get tax efficient growth and tax free amounts is useful, you don't have to specifically spend the pension on paying off the house, you can spend it on day to day living or other large purchases that you'd have otherwise needed to find the money for or make other sacrifices for. You don't necessarily have to tie the pension overpayments to the goal of paying off the house.

However if paying the house off more slowly is going to incur interest costs, then it makes sense to try to directly compare the cost of one with the benefits of the other.

As a general rule, over the long long term you should be able to achieve a better net return from a lightly taxed mixed investment portfolio, than a bank makes on its secured mortgage on your house. Whether market returns are 7% and mortgages are 3% or market returns are 15% and mortgages are 10%, you would hope it would hold true over the long long term - banks simply don't expect as much return on a secured asset as you would be able to obtain from a mixed bag of unsecured assets (assuming you held for a very long time to even out the volatility).

So, if the investment returns cover the mortgage interest and the tax advantage is tangible, what's not to like! You just need to ensure you are being realistic and be aware that if there is some sudden adverse change in rates without a commensurate increase in investment returns, you won't be able to instantly get your cash back and pay off a big slice of the mortgage with the pension money- because it's inaccessible until 55. Clearly there are some risks as others have pointed out. If you are uncertain you could adopt some compromise solution between the extremes.

jamesd

PeacefulWaters wrote: »

What if you edge into your fifties and decide you hate your jobs? ... You really will be slamming the door shut on any early retirement choices.

The extra money in the pension will increase their options, though they may still need to downsize to do it.

adnanmanzoor wrote: »

Question is how will you generate income at age 64 if you payoff your mortgage with your pension?

This is planned in advance and funded by increasing the pension contributions to allow for it, much as would be done for an interest only pension mortgage.