Pay off mortgage or invest into index funds?

MaxiRobriguez

£1,000 input into your pension would mean actual contributions between £1,250 (if using a SIPP) and £1,500 (if salary sacrifice available) as they're more tax efficient.

Working capital input example over 25 years (lifetime of mortgage/when you could drawdown pension):
- Pay off mortgage: £300k
- SIPP: £360k
- Salary sacrifice: £450k

If the investments in a SIPP returned absolutely nothing for 25 years - no capital growth, no dividends, nothing, then after 25 years you'd come out equal paying off the mortgage and avoiding ~1.5% interest on the £1k per month you put in.

If your investments in salary sacrifice pension returned absolutely nothing, you'd still be £90k better off than paying off the mortgage early. 

Pension is clear and obvious choice. There would have to be a severe and sustained economic issue to generate £0 returns on your investments over such a timeframe, and if that happens then you have far more to worry about than whether or not to pay off mortgage early frankly. 

bowlhead99

MaxiRobriguez said:

Pension is clear and obvious choice. There would have to be a severe and sustained economic issue to generate £0 returns on your investments over such a timeframe, and if that happens then you have far more to worry about than whether or not to pay off mortgage early frankly. 

I am a fan of long term leveraged investing. However, if we are going to be realistic about severe and sustained economic issues, there would likely have to be one of those to allow the mortgage rate on the property to remain as low as 1.5% for 25 years. And when looking at mortgage deals from time to time (if you qualify for a deal, which you might not if there has been a house price fall or job loss at a time you are looking to refresh your deal) - they are usually LTV contingent meaning that if you pay a little more into the mortgage you can sometimes reduce your interest cost not just on the balance you have paid off, but also on the balance you have not paid off, which is not something that you get on the savings/investment side (a return on an investment you haven't yet made).

So as with everything there can be a case for a balanced approach of pros and cons rather than a raw mathematical solution based on assumptions.

Sheriff_Fatmen

Apologies if I have missed it, but I haven't seen much consideration of the risk of becoming unable to pay the mortgage monthly, like becoming unemployed, ill-health, accident etc etc.  There is always life insurance I guess, to some extent; more money down the drain.

ForestBluebells

I’ve been contemplating just this issue and currently I decided to put £200 a month into a S&S ISA as I would like to upsize eventually and I’m risking investing giving better returns than overpaying my 1.54% mortgage rate would save. Next year I’ll have another £200 a month spare to put towards housing and I’m thinking of using that to overpay the mortgage so I balance my risk. 

ian1246

This is something I've been pondering recently since we ve filled our emergency savings fund up and nearly saved up for wife's next new (2nd hand) car - meaning soon hopefully we ll have some cash we can use (providing no redundancies happen!). In my view, over such a long timescale, Investments would almost certainly give the better returns. If mortgage rates go up, presumably you'd have plenty of notice and be able to absorb the increased % cost from the extra £££'s you can currently afford to put aside for investments, whilst hopefully being able to withdraw some of your investments to pay off some of the mortgage, depending on if the figures make sense (& provided its not in the middle of a crash!).

That said - job security, health and overall wellbeing (do you want to keep working full time in your current job?) are all relevant factors which may make overpaying the mortgage a more sensible/better suited decision for yourself.

In addition - do you ever plan to move house/up-scale? If so, the extra equity you ll have to throw at a new property will likely allow you a wider selection of future houses to look at... which you probably can't put an actual £££ figure on, since there is no guarantee than when you decide to move/up-scale that your investments will be performing Ok and make cashing them in viable.

Personally, I ll probably look at a 50/50 split when we get around to having the spare cash - best of both worlds!

MaxiRobriguez

Sheriff_Fatmen said:

Apologies if I have missed it, but I haven't seen much consideration of the risk of becoming unable to pay the mortgage monthly, like becoming unemployed, ill-health, accident etc etc.  There is always life insurance I guess, to some extent; more money down the drain.

Op has £6k in easy access money and £2k they're owed from friends/family which hopefully would become available in the time of need. On a mortgage of £60k you're talking repayments of what, £300 a month? Op easily has six months they could ride unemployment, they have done exactly what they needed to do to build up a protective bubble around unforeseen events and now is the time to take advantage of tax efficient pensions.

But I agree, some sort of life or critical illness cover would be recommended, but they may already receive it from their employer. 

MaxiRobriguez

ian1246 said:

That said - job security, health and overall wellbeing (do you want to keep working full time in your current job?) are all relevant factors which may make overpaying the mortgage a more sensible/better suited decision for yourself.

You could carry the mortgage on post retirement. There's no hard and fast rules about needing to have it paid off.

Someone who has lavishly contributed to their pension using the tax breaks will have a much larger pot to service the mortgage for longer. 

Sailtheworld

MaxiRobriguez said:

ian1246 said:

That said - job security, health and overall wellbeing (do you want to keep working full time in your current job?) are all relevant factors which may make overpaying the mortgage a more sensible/better suited decision for yourself.

You could carry the mortgage on post retirement. There's no hard and fast rules about needing to have it paid off.

Someone who has lavishly contributed to their pension using the tax breaks will have a much larger pot to service the mortgage for longer. 

I'm someone who extended the mortgage right until state retirement date to maximise the capital available to go into the pension. I honestly believed it would be a sad day when I was forced to pay it back.

However, as I've got older, my attitude has changed . With every day that passes I look at the mortgage with a little less fondness. When I sold a second home recently I paid a large chunk of it off (not all of it - old habits die hard) and it felt so good. I actually worked out what it might cost me and, for me, it wasn't worth it.

No point looking forward to a lavish pension if you find yourself wishing to take a lower paid job at age 50 but still have a mortgage to service. The days of letting inflation erode a mortgage are long gone.

Not paying the mortgage is a young person's game (it seems counter intuitive at the time) but it doesn't mean it has to be all or nothing. My top tip to the OP would be to prioritise their savings rate and not to overly worry too much about the ratio of cash savings/ mortgage overpayments / pensions. A decent savings rate will allow a bit more of each.

MaxiRobriguez

Sailtheworld said:

MaxiRobriguez said:

ian1246 said:

That said - job security, health and overall wellbeing (do you want to keep working full time in your current job?) are all relevant factors which may make overpaying the mortgage a more sensible/better suited decision for yourself.

You could carry the mortgage on post retirement. There's no hard and fast rules about needing to have it paid off.

Someone who has lavishly contributed to their pension using the tax breaks will have a much larger pot to service the mortgage for longer. 

I'm someone who extended the mortgage right until state retirement date to maximise the capital available to go into the pension. I honestly believed it would be a sad day when I was forced to pay it back.

However, as I've got older, my attitude has changed . With every day that passes I look at the mortgage with a little less fondness. When I sold a second home recently I paid a large chunk of it off (not all of it - old habits die hard) and it felt so good. I actually worked out what it might cost me and, for me, it wasn't worth it.

No point looking forward to a lavish pension if you find yourself wishing to take a lower paid job at age 50 but still have a mortgage to service. The days of letting inflation erode a mortgage are long gone.

Not paying the mortgage is a young person's game (it seems counter intuitive at the time) but it doesn't mean it has to be all or nothing. My top tip to the OP would be to prioritise their savings rate and not to overly worry too much about the ratio of cash savings/ mortgage overpayments / pensions. A decent savings rate will allow a bit more of each.

It's not just about inflation eroding the mortgage but the ability to dodge the 20%+ tax.

£1,000 a month for 25 years... if you can salary sacrifice at basic rate tax rather than use it to pay off the mortgage, then over course of that time frame, even with 0% investment gains, £0 in dividends and even considering you could have avoided the interest on the mortgage, you'd still be £100k better off.

Risk reward is massively in favour of pension and for efficiency purposes should be pushed as hard as possible. Only risk to this is affordability of mortgage if losing your job (if you haven't managed to build up a decent emergency pot because all additional capital was going into pension).

Sailtheworld

MaxiRobriguez said:

Sailtheworld said:

MaxiRobriguez said:

ian1246 said:

That said - job security, health and overall wellbeing (do you want to keep working full time in your current job?) are all relevant factors which may make overpaying the mortgage a more sensible/better suited decision for yourself.

You could carry the mortgage on post retirement. There's no hard and fast rules about needing to have it paid off.

Someone who has lavishly contributed to their pension using the tax breaks will have a much larger pot to service the mortgage for longer. 

I'm someone who extended the mortgage right until state retirement date to maximise the capital available to go into the pension. I honestly believed it would be a sad day when I was forced to pay it back.

However, as I've got older, my attitude has changed . With every day that passes I look at the mortgage with a little less fondness. When I sold a second home recently I paid a large chunk of it off (not all of it - old habits die hard) and it felt so good. I actually worked out what it might cost me and, for me, it wasn't worth it.

No point looking forward to a lavish pension if you find yourself wishing to take a lower paid job at age 50 but still have a mortgage to service. The days of letting inflation erode a mortgage are long gone.

Not paying the mortgage is a young person's game (it seems counter intuitive at the time) but it doesn't mean it has to be all or nothing. My top tip to the OP would be to prioritise their savings rate and not to overly worry too much about the ratio of cash savings/ mortgage overpayments / pensions. A decent savings rate will allow a bit more of each.

It's not just about inflation eroding the mortgage but the ability to dodge the 20%+ tax.

£1,000 a month for 25 years... if you can salary sacrifice at basic rate tax rather than use it to pay off the mortgage, then over course of that time frame, even with 0% investment gains, £0 in dividends and even considering you could have avoided the interest on the mortgage, you'd still be £100k better off.

Risk reward is massively in favour of pension and for efficiency purposes should be pushed as hard as possible. Only risk to this is affordability of mortgage if losing your job (if you haven't managed to build up a decent emergency pot because all additional capital was going into pension).

They're quite big numbers but there are a few things to remember...

(1) The OP's mortgage is only £64k. Even if they decided to put all of the £1000 month into the mortgage as overpayments they'd have it paid off in 5 years (probably less). They'd still have 20 years to salary sacrifice £1000/ month plus the mortgage payment. The sums would still be in favour of investing I'm sure but they should at least be done to allow a real like for like comparison.

(2) The tax isn't being dodged - it's being deferred. It's likely that the OP won't pay 20% on the way back out but that's by no means guaranteed so that's a risk. Again the sums would be in favour of investing assuming the status quo with tax treatment but you can't assume 20% tax saved now vs 0% tax paid in the future. As a general principle I think tax should be deferred for as long as possible but it's a consideration that should be taken in the round.

(3) There aren't any free lunches and it's unlikely there's a massive risk / reward mismatch. If there's a lop-sided return for what seems like not much more risk there are probably risks that haven't been considered  albeit the tax system does help mitigate some of those risks (for now).

You have to account for risk - I think 50:50 is about right but I'd also start thinking early about diverting payments into ISAs - the OP seems to be doing really well and 20% tax saved today vs 40% tax paid tomorrow would look like a false economy. This would also prevent them getting stuck in the no mans land of a great pension to look forward to but fewer options for retiring early.