Question on overpaying mortgage vs S&S ISA

brotherbarry

Hi All,

Have been reading this forum for a few months now...and finally decided to post after getting stumped on this question...

Now, I'm a few years away from getting together a deposit for a house, but the popular message here seems to be;
With current low interest rates, its better to invest in S&S ISA rather than ovepay on the mortgage.

If I understand this correctly, this is because the long term returns through the ISA (~6%) are greater than the cost of the interest on the mortgage (let's say 2%).

Finally, getting around to my question... but what about taking into account the returns on the increased equity of the house price? Does this also need to be taken into account...you effectively get a return of 2% through reducing interest costs...but also increase your exposure to house prices (let's say 6% return).

Haven't crunched the numbers, but my intial feeling is, a first time buyer who plans to move on, is better off overpaying the mortgage and increasing their exposure to the equity. Less important if you don't plan to move.

Is this correct, or have I completley missed the plot?

steampowered

Finally, getting around to my question... but what about taking into account the returns on the increased equity of the house price? Does this also need to be taken into account...you effectively get a return of 2% through reducing interest costs...but also increase your exposure to house prices (let's say 6% return).

This is an irrelevant consideration. As the owner of the property you benefit from any house price increase (or lose out from any house price reduction).

The mortgage lender does not get a share of increased equity. The lender just gets the loan back plus interest.

Linton

Paying off the mortage doesnt give you increased exposure to house prices. You are fully exposed to the value of the house anyway. One could argue that with a high mortgage your % gain from house prices is higher since you get all the benefit and your lender gets none.

Gains from the value of your home arent as valuable as gains from investments whilst you need somewhere to live. Any gain from an old house will usually be swallowed up by an increase in the cost of the new one.

brotherbarry

Agreed, the lender does not get a share of increased equity, but you increase your exposure to equity plus reduce interest expense cost?

Let's say you start the year with 50k equity, make 0.5k mortgage payments a month (Option A), or make 0.5k payments per month (Option . Simplistic calculations give;

Option A
Equity is now 50k + 6k = 56k
Assuming a 6% increase in house prices, equity is now worth £59,360, a £3,330 increase
Plus, assume the 10k is placed in S&S ISA earning an ~6% return = £10,600, a £600 increase
Total benefit of option A = £3,960

Option B
Equity is now 50k + 6k + 10k = 66k
Assuming a 6% increase in house prices, equity is now worth £66,960, a £3,960 increase
Total benefit of option B = £3,960 + saving from overpaying in the long term

Simplistic calculations and strong assumptions e.g. growth rates for S&S ISA and house prices is the same.

cashbackproblems

Why are you worrying about overpaying a mortgage you don't even have?!


I personally am on a 1.8% rate, instead of overpaying I put £100p/m into one fund which I know will grow by 5-15% per year, with the intention of this to be sold and used for the mortgage in the future..either overpay or safety after redundancy or when buying the next house etc. Sticking to one specific fund allows me to keep this money separate.

kidmugsy

OP, here's your homework. Hand it in for marking on Monday.

Analyse the discussion thread at
http://monevator.com/weekend-reading-weirdly-busy-august-edition/#comments

Linton

brotherbarry wrote: »

Agreed, the lender does not get a share of increased equity, but you increase your exposure to equity plus reduce interest expense cost?

Let's say you start the year with 50k equity, make 0.5k mortgage payments a month (Option A), or make 0.5k payments per month (Option . Simplistic calculations give;

Option A
Equity is now 50k + 6k = 56k
Assuming a 6% increase in house prices, equity is now worth £59,360, a £3,330 increase
Plus, assume the 10k is placed in S&S ISA earning an ~6% return = £10,600, a £600 increase
Total benefit of option A = £3,960

Option B
Equity is now 50k + 6k + 10k = 66k
Assuming a 6% increase in house prices, equity is now worth £66,960, a £3,960 increase
Total benefit of option B = £3,960 + saving from overpaying in the long term

Simplistic calculations and strong assumptions e.g. growth rates for S&S ISA and house prices is the same.

Assume £100K house, £50K mortgage, mortgage 1% interest only, you have £5K/year spare cash
House price increase=investment return =6%.

Initial assets £100K house - £50K mortgage=£50K

Case A

---

At start of each year pay £5K off mortgage from spare cash.
At end of year 1 assets:
£106K house - 1% X £45K interest -£45K mortgage=£60550
At end of year 2 assets:
£112360 house -1% X £40K interest - £40K mortgage=£71960

Case B

---

At start of each year pay £5K into 6% returning investment from spare cash
At end of year 1 assets:
£106K house + £5K investnent + £300 return -1%X£50K interest - £50k mortgage=£60800
At end of year 2 assets:
£112360 house + £10300 investment + £618 return - 1%X£50K interest -£50K mortgage=£72778

brotherbarry

Thanks all for the replies!

cashbackproblems wrote: »

Why are you worrying about overpaying a mortgage you don't even have?!


I personally am on a 1.8% rate, instead of overpaying I put £100p/m into one fund which I know will grow by 5-15% per year, with the intention of this to be sold and used for the mortgage in the future..either overpay or safety after redundancy or when buying the next house etc. Sticking to one specific fund allows me to keep this money separate.

Nothing wrong in planning ahead

I'm trying to build a rough 5 year plan, so needed to think about what would I do when I eventually do get round to buying a house...

I do like the idea of keeping to one fund, helps ring fence the money rather than losing track of it

Linton wrote: »

Assume £100K house, £50K mortgage, mortgage 1% interest only, you have £5K/year spare cash
House price increase=investment return =6%.

Initial assets £100K house - £50K mortgage=£50K

Case A

---

At start of each year pay £5K off mortgage from spare cash.
At end of year 1 assets:
£106K house - 1% X £45K interest -£45K mortgage=£60550
At end of year 2 assets:
£112360 house -1% X £40K interest - £40K mortgage=£71960

Case B

---

At start of each year pay £5K into 6% returning investment from spare cash
At end of year 1 assets:
£106K house + £5K investnent + £300 return -1%X£50K interest - £50k mortgage=£60800
At end of year 2 assets:
£112360 house + £10300 investment + £618 return - 1%X£50K interest -£50K mortgage=£72778

Excellent! Thank you very much! Makes this a lot more clear. I can see how I was misunderstanding this now. I would then assume, if we were to switch it around to a repayment mortgage, the difference between the two options would just become larger

badmemory

What about - 10% deposit and x% interest mortgage fixed for 2 years. At the end of 2 years between overpayments and increase in value, equity now 20% leadiing to x-y % interest rate mortgate.

A house is only worth what someone is prepared to pay for it. How much the value goes up or down (once you own your own property) is pretty much irrelevant as your next property will also have the same price issues. The only real issue is to make sure you don't get stuck in negative equity.

fiisch

Am in a similar position - we are fairly early on in our mortgage-paying days (had a place since 2012, moved in 2015) so we have about £70k equity in a £400k house.

Whilst in theory S&S ISA will deliver more benefit than overpaying the mortgage, it depends on your timescale - we will likely look to move again in 5 years time. That's a relatively short period of time for an investment. If our S&S ISA has had a bad year, do we hold off? What if we really need that house in a pleasant cul-de-sac?

My personal take is to split - you can never have too many savings, but at the same time your mortgage and house prices are arguably less volatile, plus there is a certain sense of security in capturing a bigger chunk of bricks and mortar that you own, rather than seeing an investment tank and surge.

Added to this, you have the Loan To Value consideration - when you start out, 80%+ LTV mortgages are more expensive - you want to get to a better LTV asap so when you renew you'll get substantial savings on your mortgage, which will allow you to invest more. The easiest way to get there is with increasing house prices, but it doesn't hurt to overpay to ensure you get there.

So... a roundabout way of saying, I split the pot - 33% "short-term" savings (regular savers, pot for holidays, cars etc); 33% "long-term" investments (no fixed date, plan is to keep adding as necessary, although I suppose I could be tempted to dip into these for a major life event - moving house, work sabbatical etc.) and 33% overpayment on the mortgage.