Overpay mortgage or pension

claraclara

Hi All,
With savings accounts performing so poorly I was wondering, if in principle it is better practice  to overpay my mortgage (I have £85k to go with an interest rate of 1.99% or put a lump sum (10K) into my pension, with is very small... Thanks! 

AnotherJoe

Its far better financially to overpay your pension. Most likely you wouldnt be overpaying it in reality anyway since you are probably not putting enough in, in the first place, if its very small.

BUT ..... you cant really compare with savings accounts. Savings accounts are for money for use soon.  A pension is for 10, 20 30 years time. Dont mix the two up.

Make sure you have emergency money  put away first.

 

dunstonh

Financially, the pension would be expected to be best.    Mortgage is 1.99% but even bog standard basic middle of the road medium risk funds have managed over 5.5% p.a. for the last 20 years.   Plus, you say your provision is small.  So, maybe time to catch up.  Your house wont pay you a pension in retirement.   Insufficient provision may mean having to do equity release and any work to overpay the mortgage in your working life would be undone by that.

steampowered

If you are happy to lock the money away until retirement, it is far better to boost your pension:
- Pension contributions get tax relief. Tax relief adds 20% if you are a basic rate taxpayer, or 40% if you are a higher rate taxpayer.
- Pensions generate investment returns. Most pensions are invested in stock market investment returns. Over the long term your fund might generate a return of 7% per year on average. That's far more than the 1.99% you are paying on your mortgage.
 
If you are not happy to lock the money away until retirement, you should open a stocks & shares ISA. This has the advantage of generating investment returns (likely something like 7% per year on average). This is easy to do - you can simply put it all into an investment fund that is diversified across the entire stock market - something like Vanguard Global Allcap. You won't get the tax relief a pension contribution will get, but you will be able to access the money at any point. 

Albermarle

Some recent threads on same topic.
https://forums.moneysavingexpert.com/discussion/6197392/overpaying-mortgage#latest
https://forums.moneysavingexpert.com/discussion/6175734/what-to-do-with-inheritance/p1
https://forums.moneysavingexpert.com/discussion/6195994/overpaying-mortgage-instead-of-saving#latest
https://forums.moneysavingexpert.com/discussion/6196328/pension-or-mortgage#latest

Thrugelmir

Does your mortgage product allow you to overpay by £10k?

DiggerUK

Yes, check your t&c's about overpayments.

Best not pay too much attention to siren voices that you could possibly be "better financially" with increased pension contributions, or that pensions "would be expected to be best". 

With overpaying the mortgage you are guaranteed to be better off because it is a debt you must eventually dispose of and you will be increasing your stake in the asset to boot..._

grumiofoundation

DiggerUK said:

Yes, check your t&c's about overpayments.

Best not pay too much attention to siren voices that you could possibly be "better financially" with increased pension contributions, or that pensions "would be expected to be best". 

With overpaying the mortgage you are guaranteed to be better off because it is a debt you must eventually dispose of and you will be increasing your stake in the asset to boot..._

Investing, whether by paying all/some into a pension is very likely to be a better financial decision than overpaying. Can you explain how it isn't (using actual numbers). 

Overpaying the mortgage only guarantees you being better off versus spending the money or having it in a lower interest account (which for many people is actually more sensible than overpaying but that is dependant on circumstance). Paying off your mortgage early comes with an emotional security that is worth different things to different people, someone has to make the decision how much they value that themselves but you can't 'calculate' that. 

For example I would rather have 100k in cash (use cash as an example because it is equally 'low risk') even if this is earning slightly less than the mortgage interest and owe 100k more on the mortgage, some people would rather have less on the mortgage, whether due to the emotional (but not financial) security this brings them, or because they can't trust themselves not the spend it. 

As an aside - you are not increasing your stake by overpaying, you are lessening the amount you owe (subtle and important difference).

dunstonh

With overpaying the mortgage you are guaranteed to be better off because it is a debt you must eventually dispose of and you will be increasing your stake in the asset to boot..._

Of the two options given by the OP, you cannot say one is guaranteed to be better than the other.

Pension returns have historically beaten mortgage interest rates over the long term.  Not guaranteed but its a reasonable basis to work on when interest rates are so low.

Pensions get tax relief on contributions.   Assuming the op is a basic rate taxpayer, that give it a massive headstart.  Paying £10k off the mortgage means it has already suffered tax and NI.  So, £10k off the mortgage saves £199 in year one.     £10k net into a pension gets tax relief sees £12,500 invested.  A year of 5.5% would be £687.50.    

Ignoring any future growth whatsoever, £10k into the pension has increased retirement income by around £437.50 a year (and still retaining the value of the fund).  Even if that is fully taxed as the personal allowance is used up by other income, that is still £371.88 a year after tax.

None of the figures on the pension can be guaranteed as investment returns are different every year.  However, the assumptions used are reasonable and if anything understating (especially the bit where I have ignored any future growth above inflation.  i.e. assuming around 2% a year instead of the 5.5% or more).

Also, there may be other solutions that can fit as well. The OP has only mentioned mortgage or pension.  Utilising an S&S ISA or Lifetime ISA may come into play (the latter especially).

The OP has a small mortgage left and has not indicated any payment difficulties or concerns on affordability.   He has stated his pension is too low.          Making an overpayment to the mortgage gets a few years off the mortgage.  Whoopie.  Nice warm feeling until you realise that you are now much closer to retirement and still don't have enough money put aside.  You can put some of the mortgage money saved into the pension but the term is now shorter and you have missed out on years of potential returns higher than the mortgage.    With investments, time dilutes risk.  The longer you are invested, the closer you get to the long term average return.

Another scenario is paying the mortgage off early and not paying any extra into the pension.  Still get that nice warm feeling when the mortgage is cleared only to have to take out another mortgage (equity release) in retirement because you didn't save enough for retirement.  Interest rolling up on the balance every year of your life until a great chunk of your equity has been lost to the lender.    

Life doesn't have guarantees that can tell you which option is 100% better than the other.  You have to make judgement calls.

Every forum has its posters that are negative on a subject (sometimes intentionally to cause trouble) and will be biased towards or against something.   claraclara is a first time poster and won't know who those people are.   However, you have one of this thread.

DiggerUK

With pension savings or other investments "you may not get back all you put in"
Claiming that it is "very likely" or that a pension has "historically beaten" other investments overlooks the warning "that past performance is no guarantee  to future performance"
Clearing the mortgage leaves you with a guaranteed risk free asset..._

Prism

A balance is good. Somewhere between an interest only mortgage and over paying it is down to the individual. Personally I have been decreasing my payments over the years with the money going into savings instead (cash, ISA and pension). I know people who have switched completely to interest only when they get the loan to value of the mortgage to a level which gives access to low interest rates.
I know of retired people who have paid off their house and then later in life re-mortgaged the house almost completely to use the equity during retirement (to invest, spend and give away). I wouldn't especially want a debt hanging over me when retired but until that point all options are worth considering.