Overpay mortgage or pension

Sailtheworld

I don't know why this question is always either or.

The answer is probably a bit of both according to appetite for risk. A pension contribution comes with some tax benefits and the mortgage overpayment comes with a guaranteed return.

As the OP hints this question has come about because of low savings rates doesn't that imply they're more towards the mortgage payment option?

Yes, their pension needs some attention and, yes, over the long term a pension will likely be the more lucrative option so maybe they need to accept more risk but that's the answer to a different question.

Time4T_Accounts

My approach was fourfold (when the income could sustain it) ...
Overpay the mortgage... for that nice warm feeling...:
Pay into a Rainy Day fund ... you can always pay this into your pension in the fullness of time, if it hasn’t rained;
Make some pension payments... let dividend reinvestment work its magic over time;
Finally - enjoy the present!

steampowered

DiggerUK said:

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..._

Paying off the mortgage does not increase your stake in an asset. Your property is worth the same whether it has a mortgage on or not.

Why would you choose to pay off a debt which has an interest rate of 2% on it. When you could instead buy an asset (shares) that generates around 7% per year on average.

Not to mention that the government will top you up an extra 20% or 40% (depending on whether you are a basic or higher rate taxpayer) - and you get investment returns on that extra 20% or 40% too.

DiggerUK

Overpaying the mortgage does increase the %ge you own  in the same way that regular mortgage payments do. 

On a capital repayment scheme you don't  pay on the portion you've paid off, you pay on the portion the mortgage company owns; the market value is irrelevant.

With the illustrative figures given as an example, the 2%  is fixed and guaranteed, the 7% isn't. The pathway chosen has to be aware of what the risks and rewards are.

The funds put in the pension cannot be accessed until many years ahead, the increase in cash flow from overpayments can be accessed now and can form the basis of funding plans for retirement. Pensions are not the only show in town when it comes to retirement..._

billy2shots

As well as the guaranteed mortgage interest rate saving Vs an element of risk with pension investment plus the fact your money is locked away until you're 55/57/possibly longer if you are very young, people seem to highlight the tax saving on the way in but ignore the tax implications on the way out. 

Sure it's a net win in the very long term but it isn't as huge as is sometimes made out. The compound interesting is the single biggest benefit of investment over longer terms and although highly likely to perform better than overpaying the mortgage it is still not guaranteed and you still can't access it for X amount of years. 

Dandytf

Some excellent post, also overpaying mortgage adds some built in rate rise protection.
Though I'm finding Mortgage O/P+Pension+AVC's+S&S Isa a decent way forward, late 40's.

billy2shots

Dandytf said:

Some excellent post, also overpaying mortgage adds some built in rate rise protection.
Though I'm finding Mortgage O/P+Pension+AVC's+S&S Isa a decent way forward, late 40's.

Another excellent point. Some people ignore the risk of potential mortgage rate rises and base everything off of today's rates. 

For me personally, my mortgage (£195k left) has 8+ years remaining on a fixed product at 2.44% with no overpayment fees. Those fees could easily be 5-7% (or more ) by 2029. 

Albermarle

billy2shots said:

As well as the guaranteed mortgage interest rate saving Vs an element of risk with pension investment plus the fact your money is locked away until you're 55/57/possibly longer if you are very young, people seem to highlight the tax saving on the way in but ignore the tax implications on the way out. 

Sure it's a net win in the very long term but it isn't as huge as is sometimes made out. The compound interesting is the single biggest benefit of investment over longer terms and although highly likely to perform better than overpaying the mortgage it is still not guaranteed and you still can't access it for X amount of years. 

You are correct that for a basic rate taxpayer in employment and retirement , the tax gain is 'only ' 6.25% for a pension .Plus the downside of no access for many years . 
However this 6.25% would be a minimum gain . Anybody contributing by salary sacrifice gains more due to not paying NI on contributions.. Anybody who is basic rate in employment and a non ( or minimal )  taxpayer in retirement gain more . Plus of course anybody paying 40% tax in employment and 20% in retirement ( which is relatively common ) makes a big gain .

steampowered

Statements like "the return on shares isn't guaranteed" are wrong if we are talking about a pension. There is a guaranteed 20% or 40% gain on day-one due to tax relief.

The return on stocks and shares - which averages about 7-8% over the long term - accrues on that higher amount.

If you are a higher rate taxpayer, a return of 7% on £100 of your post-tax income, starts compounding on £140, so is really a 9.8% return if you are comparing it to the £100 (which is what you'd have if you went down the paying off mortgage route). 8.4% if you are a basic rate taxpayer.

grumiofoundation

DiggerUK said:

Overpaying the mortgage does increase the %ge you own  in the same way that regular mortgage payments do. 

On a capital repayment scheme you don't  pay on the portion you've paid off, you pay on the portion the mortgage company owns; the market value is irrelevant.

With the illustrative figures given as an example, the 2%  is fixed and guaranteed, the 7% isn't. The pathway chosen has to be aware of what the risks and rewards are.

Overpaying the mortgage does not increase the % you own, it decreases the amount you owe to the mortgage lender. This is a common misconception about mortgages. Practically there is very little difference but I don't really see the harm in being accurate? Paying £1000 off the mortgage just decreases the £1000 you owe, you don't get some magical extra profit from this based on the fact you paid off a mortgage.  

The 2% is not fixed or guaranteed unless someone has a 2% fixed mortgage for the remainder of their term. In fact one argument to overpay is mortgage interest rates might rise above 2%. 

The funds put in the pension cannot be accessed until many years ahead, the increase in cash flow from overpayments can be accessed now and can form the basis of funding plans for retirement. Pensions are not the only show in town when it comes to retirement..._

Overpaying does not increase your cash flow, in fact it decreases your cash flow. 

Paying off the mortgage completely increases your cash flow. 

The point about pension funds being inaccessible is a good one, and why a mix of stocks and shares ISAs and pensions is maybe more sensible for a lot of people.
But you neglected to mention the funds put into overpaying the mortgage can only be accessed when the property is sold.