Overpay mortgage or S&S ISA?

james_09

After a painstakingly long process I have finally re-mortgaged £525k @ 1.99% for 5 years with 30 years remaining on the mortgage as at today's date. My long term goal is to clear this mortgage in 20 years, but right now is an expensive point in our lives so a large part of that will come in later years.

For the time being due to the reduction in rates my monthly payments are going to drop by £350 a month, so I am going to start with that towards clearing the mortgage early.

Originally I had planned to use this to overpay the mortgage for the next 5 years, but now I am wondering if it would be better to invest this in a S&S ISA, as my wife currently has enough spare ISA allowance to utilise this. I could then use the money to pay a lump sum off the mortgage at the end of 5 years.

The question is whether 5 years a long enough time period to try and beat 1.99% return a year?

I am a bit torn because obviously there is risk here that I make less than 1.99% a year and there is risk to the capital vs guaranteed 1.99% return and no risk to the capital if I overpay.

I was thinking of sticking it in VLS 80 fund, but should I be looking at maybe VLS 60 or VLS40 on a 5 year time frame? Or something else?

If I get to 5 years time and interest rates are still low I would probably roll this over for another 5 year fix, so I wouldn't necessarily have to sell up the investments in 5 years time. If interest rates skyrocketed I would want to use the money to pay down the mortgage regardless.

What would you do?

MaxiRobriguez

Depends on your earnings. £500k of mortgage could be a weight round the neck or it could be serviceable depending on your earnings.

If it helps, I earn a salary starting with a 6, albeit five figures, and in your situation, with markets currently at record prices and global growth receding, I would overpay the mortgage. Markets might return a better outcome but presumably to afford a house which by the sounds of it is might be around £700k or so you're not in your twenties. If interest rates rise only a little and stocks cool off, you lose the ability to overpay for a number of years which might end up with you tying yourself in to paying what might be an expensive mortgage possibly well into retirement.

We're coming to the end of a bull-market, pay down debt rather than chase gains if you're not on mega bucks. There will be opportunity to pick up cheaper investments shortly.

pinknsparkly

It comes down entirely to your risk preference. As you have already identified, overpaying the mortgage gives you a guaranteed 1.99% "interest" on your savings whereas investing in stocks and shares has a good chance of beating this, but also a risk of returning less than you invest.

Another thing to consider is what your LTV is likely to be when you come to the end of the 5 years? If overpaying is likely to bump down down into a lower category, and so be eligible for lower interest rates, then I would consider at least overpaying enough to bump you into the lower category. Then, if your investments haven't performed well, you can leave them put for another 5 years whilst you fix again.

What do you consider by "sky rocketed" interest rates? 5%, 10%, 15%? Would you be annoyed with yourself for going down the investment route in this instance, or would you be ok with it in the knowledge that you tried and it didn't pan out?

Personally, I am taking the approach of investing the majority of our overpayments, and not getting them out (regardless of what interest rates do in the meantime) until they are sufficient to pay off the mortgage entirely on the basis that over the long term (in my case, I'm talking 20+ years) that should beat the mortgage interest. I then make actual overpayments throughout the month by rounding down my balance to the nearest £5 each day and sending any cashback etc to the mortgage.

Perhaps you could split your overpayments between mortgage and investment? At the end of the day, you have to decide if you're happy to take a risk and can deal with it not working out the way you hoped in the hope of a more lucrative outcome, or you can go for the safe option that guarantees a win, just not as substantial a win! There's definitely nothing wrong whatsoever with going down the overpayment route instead of investing if that's what helps you sleep more soundly at night!

cloud_dog

MaxiRobriguez wrote: »

Depends on your earnings. £500k of mortgage could be a weight round the neck or it could be serviceable depending on your earnings.

If it helps, I earn a salary starting with a 6, albeit five figures, and in your situation, with markets currently at record prices and global growth receding, I would overpay the mortgage. Markets might return a better outcome but presumably to afford a house which by the sounds of it is might be around £700k or so you're not in your twenties. If interest rates rise only a little and stocks cool off, you lose the ability to overpay for a number of years which might end up with you tying yourself in to paying what might be an expensive mortgage possibly well into retirement.

We're coming to the end of a bull-market, pay down debt rather than chase gains if you're not on mega bucks. There will be opportunity to pick up cheaper investments shortly.

As it is really only a 5 year period, and you have stated that your intention was to use it to pay off the mortgage, and (and) you seem to have a low(ish) risk tolerance, I would suggest keeping it simple and simply overpay the mortgage.

bowlhead99

Personally I don't think 5 years is a long enough time to be confident of beating 2% a year.

People say "don't invest unless you can do it for the long term" not because it is technically impossible to do for less, but because doing it for the long term you are much more likely to achieve the 'going rate' for the risk you are taking.

So for example you might think that 'inflation plus 3-5%' is a fair return for the risks being taken, but the actual return will not be that rate in each and every year. You get good years and bad years and flattish years and nothing years ; only in the 'long term' should investing in risk-based, productive assets deliver you a return that you think is fair for all the calamities that could happen along the way.

For example, it wouldn't be impossible for VLS80 to drop 40% and stay there a year or two before starting to gradually recover, slowly. If it turns your £20k of 'alternatively invested mortgage overpayments' into £12-15k, that is not going to help you when you need to put £20k into getting your loan-to-value under a certain threshold for remortgaging. And remember if it causes you to miss a LTV threshold at renewal you will be paying a fraction of a percent per year more not just on the £20k but on the whole 4-500k amount you are trying to borrow.

The problem with the state of the markets at the moment is that traditionally 'safe' investments are yielding a pittance (due to interest rates being low generally). You are not going to get 2% in an S&S investment ISA invested in short dated UK government bonds, and if you invest in riskier or longer-dated bonds you don't get high rates while on the downside you could get a capital loss.

Whereas at the other extreme if you got a global equities index tracker, with most of the shares being listed in foreign stockmarkets or having their assets or incomes in foreign countries, you could face a peak-to-trough drawdown of 50%+ over the course of a couple of years.

By necessity, a 'medium risk' investment that tries to return appreciably more than 2% a year over a five year period is going to give you that blend of 'low returns', 'lowish returns with chance of capital loss' and 'higher returns with chance of devastating capital loss'. You can use all sorts of mixed-assets solutions to try to find a blend between the returns that might be available, and there are some middle-ground options which might give you a decent income without too much risk. BUT it is still risk and ten to fifteen years is more likely to give an investment product a fairer time in which to deliver what it says on the tin.

Having said that you need ten to fifteen years, consider how much time in the market you will have if you drip feed money into an investment ISA from now until five years is up. You are investing £21k. The first £350 gets the full 60 months in the market. The last £4k gets less than a year in the market. On average, your £21k is only deployed for two and a half years.

Frankly if there is a global crash next week, great, because everything after the first £350 will be invested at cheap prices and might recover to turn a profit in five years time. Whereas if everything is fine or going up for a while it will be very annoying if there is then a crash in 2022 causing markets to hit their lows just in time for your mortgage renewal date in summer 2024 and then take until 2029 to recover properly.

It is for this reason that I am overpaying my 1.94% mortgage (four years left to run on the deal) by a few hundred pounds a month when I have some ISA capacity and plenty of pension capacity. A couple of percent mortgage interest saving is a reasonable post-tax return for something risk free.

One thing you could consider between you and your wife is putting the monthly spare money into a 'regular saver' account with a bank or building society which gives a high interest rate in exchange for limits on the amount of monthly contributions for a year. First Direct pay 5% on up to £300pm, Lloyds Club pays 2.5% on up to £400pm, Virgin Money 3% on £250pm without requiring any other account with them, but you have to visit a branch. There are others.

If your wife has spare personal savings allowance and would not pay tax on this interest income (or if she doesn't but is a low rate taxpayer), you will be left with a better result over a year than if you had just taken the 1.99% by repaying the mortgage, and it carries no greater risk. At the end of the year you will have a few thousand quid which can be paid off the mortgage if you want to at that point, or function as an 'emergency fund' (which may be lacking if you had recently stretched yourself to secure your last mortgage deal).

james_09 wrote: »

If I get to 5 years time and interest rates are still low I would probably roll this over for another 5 year fix, so I wouldn't necessarily have to sell up the investments in 5 years time. If interest rates skyrocketed I would want to use the money to pay down the mortgage regardless.

Although you mention here that it's not necessarily only a 5-year consideration (because hopefully you will roll it over if a good mortgage rate exists), you have confirmed that you'll want to pay off the mortgage if rates are high, so you do need to consider that as an outcome and then practically you do need to consider it as a five year game rather than a ten year one.

I think it makes sense to keep the money flowing into a mortgage (or higher interest risk-free savings which can then help to pay off the mortgage) rather than add to the investment pot. One thing unconnected to the absolute best financial outcome is that it helps enforce the 'discipline' of clearing the mortgage and having a high figure coming out of your account to fund your house, rather than seeing money being added to your investments / general wealth balance. We won't have the luxury of low interest rates for the whole course of your 20-30 year mortgage so psychologically it's not bad to be in the habit of seeing £x go out the door towards a mortgage obligation rather than only £y for mortgage and £z towards investment.

james_09

Thanks for all the comments so far. I also forgot to mention that the mortgage is tied to an offset account, so I do have the option of putting the money in there and still keeping the capital available.

I do really like the idea of the 5% savers and then transfer back to the offset account/over pay. I might do this initially as it buys me another year before I have to decide what to do with the first years overpayments.

To give a bit more detail on our circumstances I'm 37 and my wife is 40. I can access my SIPP at 57 and my wife can access her final salary pension at 60. So we have a very loose goal of retiring in 20 years at which point I would want the mortgage cleared. This also ties in with the kids finishing uni if they decide to go.

The mortgage actually just fell into the 60% loan to value this time round, but because my wife only works part time whilst the kids are very young, we were borrowing close to the max anyone would lend, so we were very limited in the mortgages available.

However, at the end of this 5 year fix my wife should be back at work full time, kids will be at school and no nursery fees so things should be a lot more comfortable.

To answer the question of what I consider to be high interest rates, I guess if the cheapest mortgage rate I can get is over 5% (I know not high by historical standards) I would not be willing to put any capital at risk in an attempt to get a higher return.

I would then not be comfortable leaving whatever "over payment" capital I had in the stock market and look to pay down the mortgage immediately. If rates were under 5% I would probably look to roll it all on for another 5 years.

MaxiRobriguez

james_09 wrote: »

Thanks for all the comments so far. I also forgot to mention that the mortgage is tied to an offset account, so I do have the option of putting the money in there and still keeping the capital available.

Gamechanger.

Put the money in the offset and hang fire. You can sit on guaranteed 2% returns and simply see if stocks tank over the course of the next 2-3yrs, in which case you can pick them up on the cheap with the cash saved in the offset.

That's what I'm doing. I've got almost 100% of my mortgage as cash in the offset, of which 50% is ready to fire in such an event. If not, no bother, risk free 2% each year.

ChrisJ1988

It really is up to you and your attitude to risk. Another option, depending on your individual situation would be to may more into your pension tax free. I am assuming you are a higher rate tax payer so this would give you a 40% saving stright away.

Me personally, I pay more into my pension and have a stocks and shares ISA. Overpaying my mortage(fixed at less than 2%) is the last thing on my mind. However having said that I know that if my ISA doesnt perform I will be ok.