Overpaying mortgage instead of saving.

steampowered

Paying off the mortgage does come with a "feel good" factor.

However, much like going on a luxury holiday, that comes with a price tag. The cost of overpaying the mortgage rather than investing is significant. The question people should ask is what is that "feel good" feeling worth to them. £20,000? £40,000? £100,000? £500,000?

Imagine someone who has a £500,000 mortgage, and decides to overpay the mortgage to clear it in 10 years, rather than 20 years. Let's estimate the cost of doing that:
- Interest rate on mortgage - Assume 2%.
- Investment return on investments - Assume 6% (which is the average long term return you might get from a medium risk investment fund).
- The net gain by investing is therefore 4% per year.
- Let's assume for simplicity that the average balance of the mortgage over the term is £250,000.
- Therefore, we are looking at a 4% difference on £250k for over 10 years.  

The cost to that person of paying off the mortgage early, rather than investing, is £120,061.

And that's before taking account of the impact of tax relief if money is going into a pension, which for higher rate tax payers will boost that figure by 40%.

Personally, I would rather have the £120k.

Biggus_Dickus

Albermarle said:

Rule of thumb of where your money should go once you've built a decent emergency buffer:
- Pension
- S+S ISA
- Pay off mortgage
- Savings

This for most people is the rational advice , especially if you have secure employment.

However it is clear that for many people paying off the mortgage is an emotional goal and if you are in insecure employment it could also be the rational route.

Probably for most people in the end it will be a mixture of everything rather than either/or. 

Paying off your mortgage early, whether in full or in smaller chunks, does have several advantages. It’s tangible for as start,...you know exactly where your money is going and exactly what you getting in return for that money,...plus, as you say, there is an emotional element to it as well.

I paid off my very sizeable mortgage many years ago by selling my mortgage endowment policy on the open market and using the proceeds to pay-off most of my remaining mortgage. I paid the remainder off within just a couple of years.

It was a different era of course but many people who sold their mortgage endowment policy’s used the cash to fund an extravagant lifestyle for a short while and then found themselves in dire financial straits when their original mortgage term ended. A close work colleague/friend of mine used his endowment policy cash to make ill-advised investments and within a couple of years his cash had dwindled to a fraction of its original value,...but saying that, if his investment had turned out well then probably I would have been ruing the fact that I didn’t follow his lead.

I know finance is more sophisticated these days but all things considered, I reckon paying-off my mortgage early was one of my wiser decisions (in amongst several unwise financial decisions, I might add!).  :'(

 

MaxiRobriguez

steampowered said:

Paying off the mortgage does come with a "feel good" factor.

However, much like going on a luxury holiday, that comes with a price tag. The cost of overpaying the mortgage rather than investing is significant. The question people should ask is what is that "feel good" feeling worth to them. £20,000? £40,000? £100,000? £500,000?

Imagine someone who has a £500,000 mortgage, and decides to overpay the mortgage to clear it in 10 years, rather than 20 years. Let's estimate the cost of doing that:
- Interest rate on mortgage - Assume 2%.
- Investment return on investments - Assume 6% (which is the average long term return you might get from a medium risk investment fund).
- The net gain by investing is therefore 4% per year.
- Let's assume for simplicity that the average balance of the mortgage over the term is £250,000.
- Therefore, we are looking at a 4% difference on £250k for over 10 years.  

The cost to that person of paying off the mortgage early, rather than investing, is £120,061.

And that's before taking account of the impact of tax relief if money is going into a pension, which for higher rate tax payers will boost that figure by 40%.

Personally, I would rather have the £120k.

I agree with this, and these numbers and this explanation is why I'm borrowing more on the mortgage in order to be able to sacrifice more salary into the pension (all the way down to minimum wage) in order to benefit from reduced tax and probable gains.

However, people going down this route need to be aware of potential illiquidity of this approach. Sacrificing money into the pension means it's not accessible until 55 or 57 so you could be 10, 20, 30 years away from accessing the money, whereas overpaying the mortgage will likely be accessible within two years for most people, assuming they've bought a two-year fix product.

Going big on sacrificing pension is fine, just make sure you have a decent emergency savings pot alongside. 

MovingForwards

@steampowered
My mortgage is 5.57% as I'm with a sub-prime lender. 5 year fix, but hopefully remortgaging in 18ish months.
When I've remortgaged I will split the difference between SIPP, savings and mortgage O/Ps to meet 10 year plan.

I'm paying into a DB pension, not sure how long I will stay with them; could be 2 - 5 years, could be longer. I prefer private sector employers.

On top of that I'm now paying into a SIPP to cover early retirement eg before SPA. Will increase payment in each year.

Plus I'm also saving to potentially retire a few years before the minimum age for taking pensions.

I did put a post up on the pensions board a few months ago, but am already doing the plan I had for 2022.
(Edit to add correct year for plan)

Thrugelmir

Many people as they get older find their employment less secure. Being mortgage free is the best way of lifting the burden of having to earn "x" per month. Spread your money across various pots. That way whatever curved balls life throws at you easier to adjust. 
Relationship breakdown is another factor which throws best laid plans off track. When both of you need someone to live. That equity may not go far. 

MaxiRobriguez

MovingForwards said:

@steampowered
My mortgage is 5.57% as I'm with a sub-prime lender. 5 year fix, but hopefully remortgaging in 18ish months.
When I've remortgaged I will split the difference between SIPP, savings and mortgage O/Ps to meet 10 year plan.

I'm paying into a DB pension, not sure how long I will stay with them; could be 2 - 5 years, could be longer. I prefer private sector employers.

On top of that I'm now paying into a SIPP to cover early retirement eg before SPA. Will increase payment in each year.

Plus I'm also saving to potentially retire a few years before the minimum age for taking pensions.

I did put a post up on the pensions board a few months ago, but am already doing the plan I had for 2021.

At a rate like that there is benefit to overpaying alongside investing, and paying into a SIPP alongside your DB for earlier retirement is sensible. 

MovingForwards

@MaxiRobriguez that's why I ran it by the guys on the pensions board, as I know a lot of people have normal interest rates. 
It was actually 2022 I had planned to start paying into a SIPP, but my savings are on track and that's why I started it this month. 3 of my old pensions are in / being transferred to it. 
I've kept two as 'small pots' (unless the rules change); one performs ok, the other is the typical cheap one employers use.

It was only because I worked from SPA to current age, I knew what I needed / wanted for each stage of life.

Albermarle

I'm paying into a DB pension, not sure how long I will stay with them; could be 2 - 5 years, could be longer. I prefer private sector employers.

I think most people would much prefer a DB scheme !

solidpro

We paid our mortgage off in 2016. However I decided that whilst we saved some money on interest, it would be a good investment to re-mortgage £100k and use that towards buying a house a few doors away and renting it as a BTL through our own private limited company (which we personally provided a director's loan to).

The rent on a 3 bedroom house near us is £1350 a month which pays our mortgage, it's own mortgage and leaves about £350 a month left over. In 20 years we'll have the full income from it as a contribution towards our monthly income and the always have the value of the house when sold (less any CGT on profit).

It's a bit more work than sitting on a paid off house, but to us is a warmer feeling than simply sitting 100% of our on our money in bricks and mortar around our bodies and saving 2% of interest on £100k which is covered by the BTL house rent.

Today it's 75% of our money owning our own house and 55% of another - enough to easily weather a housing market crash and sit out any storms for 20 years.

steampowered

MovingForwards said:

@steampowered
My mortgage is 5.57% as I'm with a sub-prime lender. 5 year fix, but hopefully remortgaging in 18ish months.
When I've remortgaged I will split the difference between SIPP, savings and mortgage O/Ps to meet 10 year plan.

Yes it makes complete sense to overpay that mortgage ASAP, given the rate you are paying.

Fingers crossed that you will be able to remortgage soon! Then you can consider building up your pension and stocks & shares ISAs, to get you into a good position for retirement.