Psychological (and economic) benefits of investing/saving vs overpaying mortgage

stuart746

Hello All,
I have been mulling the following over for quite a few months now and am no nearer to making a clear decision, and would appreciate any advice/comments.
My wife and I have a good household income (approx £120k a year) and in stable employment with good DB pensions. We are in both in our late 40s with teenage children. We have a mortgage remaining on our house of about 200k (house value is currently 700k), which we would like to pay off by retirement if not before. At the currently rate of repayment the mortgage will be paid off by the time we are at state pension age, but I would like to reduce the term to age 60 or overpay the mortgage. My current plan has been to both save (at pitiful interest) and invest the overpayments, but knowing that there is a risk that in 10-15 years time investments could not reach the amount required. I have also been paying extra into my pension with a view to using any tax free lump sum to pay off any remaining mortgage. I like the principle of saving and investing the extra money we could put to overpaying, but know the investment part carries risk. By overpaying the mortgage it reduces the interest and there is no saying interest rates will not rise significantly over the next 10 years.
I could take a mixed strategy (overpay + invest and save), or any combination, but wondered if anyone else had been in a similar position and felt that there are psychological as well as economic benefits from choosing one approach over the other. It is suggested that feelings of happiness, control and wellbeing reduce with larger debts like mortgages, but I wonder if saving and investing large amounts offset this?
Happy to give more detail if that will be useful.
Thanks.

anxiousnow

We decided our current strategy (given poor interest rates and a potential future hike in mortgage interest rates) is to plough as much as we can into mortgage overpayments (while keeping an emergency fund). My view is that the interest benefits of overpaying outweigh the potential wins in stocks and shares, but of course, that's a personal decision and depends if you know what you're doing investment-wise and your appetite to risk. 

stuart746

anxiousnow said:

We decided our current strategy (given poor interest rates and a potential future hike in mortgage interest rates) is to plough as much as we can into mortgage overpayments (while keeping an emergency fund). My view is that the interest benefits of overpaying outweigh the potential wins in stocks and shares, but of course, that's a personal decision and depends if you know what you're doing investment-wise and your appetite to risk. 

Thanks for the response, I think I have a low tolerance for risk, or at least quite a conservative one.
As a matter of interest, how did you decide what needed to go into the your emergency fund? I find this interesting as if you read these boards the EF varies considerably depending on what people count as an emergency.

Alexland

Well any reasonable projection will tell you that over the long term it likely gives most financial benefit to make pension and S&S ISA contributions especially if you can keep your income low enough to get full child benefit. We are a bit younger and so also get additional benefit from investing via our Lifetime ISAs. Our plan is also to repay the mortgage via a pension lump sum and already have accumulated enough to do that. We just extended our mortgage back to 25 years to give us the maximum flexibility on when we make the lump sum repayment as stock market conditions for making the withdrawal can vary.

In the meantime it's not ideal having a mortgage unnecessarily hanging over our heads requiring monthly interest payments with the risk they could increase but then we counter balance that by having enough investment trust units in our S&S ISAs that produce reliable smoothed growing income that is greater than the mortgage value and rate so even if we lost our jobs the mortgage and some of our bills would be paid even if rates rise. While we don't need the dividends we just reinvest them with new contributions but it's reassuring to see they are available if needed.

Don't do anything that would stop you sleeping at night but sometimes there are reasonable compromises you make in how you arrange your finances to get a likely better outcome and build wealth to get into a good position to help your kids when they get a bit older. Still if you want certainty then you have to accept there is an opportunity cost of paying back the mortgage early.

stuart746

Thanks Alexland for your considered response.
It seems like you have established a clear strategy, but being on the wrong side of my 40s I just wonder if that is now playing on my mind (age 60 years suddenly doesn't seem very far away, but in my early 40s I felt very different). As I said, I'm not sure I have had a strategy apart from seeing debt reduction (mortgage) and building wealth (saving/investing) as two sides to the same coin. I will review my pension projects and see if this will make a difference. I know that by 60 if I keep going the way I had been I will have 50% of the remaining amount to pay off, which is possible, but at what cost to my pension.
Will paying off my mortgage make me sleep better... very possibly, but I can also see your point about the opportunity cost which requires a longer-term investment approach.

Albermarle

but wondered if anyone else had been in a similar position 

Not personally but it is a very common question on this forum .

The answer is usually as long as your job is safe then it is better to invest ( in pension, ISA etc ) than overpay your mortgage, unless it has an unusually high interest rate . That is the rational answer, but emotionally paying off the mortgage feels better to many . 

You have already worked out this dilemma for yourself , and the real answer is that is up to you. Do one or the other or both , only you can decide what is right for you.

In reality with a household income of £120K and good DB pensions , whatever you do you will still be better off than 98% of the nation , so perhaps not worth worrying about too much anyway .

Apodemus

You are quite right about the psychology issue - while it certainly seems logical to invest rather than pay off the mortgage, the peace of mind from paying it off and being completely debt-free is a huge benefit.  I paid mine off about ten years ago and have no regrets, even if the cash might have done better if it had been invested.   

stuart746

Albermarle said:

but wondered if anyone else had been in a similar position 

Not personally but it is a very common question on this forum .

The answer is usually as long as your job is safe then it is better to invest ( in pension, ISA etc ) than overpay your mortgage, unless it has an unusually high interest rate . That is the rational answer, but emotionally paying off the mortgage feels better to many . 

You have already worked out this dilemma for yourself , and the real answer is that is up to you. Do one or the other or both , only you can decide what is right for you.

In reality with a household income of £120K and good DB pensions , whatever you do you will still be better off than 98% of the nation , so perhaps not worth worrying about too much anyway .

Thanks, I appreciate that I am in a fortunate position, which I worked hard for, but it is useful to see the rational answer.
Lessons in behavioural economics suggests that we do not always behave rationally (I read a lot of Richard Thaler's work on behavioural economics - highly recommended btw!), so I know rationally that I should invest given low interest rates, etc, but I'm driven emotionally on some decisions and this can cloud judgement.

stuart746

Apodemus said:

You are quite right about the psychology issue - while it certainly seems logical to invest rather than pay off the mortgage, the peace of mind from paying it off and being completely debt-free is a huge benefit.  I paid mine off about ten years ago and have no regrets, even if the cash might have done better if it had been invested.   

Thanks, yes I have heard that too from people who have paid off their mortgage. It would be hard to regret such a decision, though I'm sure there are people who may have felt that they lost out on gains in other areas like investing or pension contributions.
Paying off the mortgage was the norm to people of my parents generation, but today less so I think as we have historically low interest rates and fewer limits on mortgage age restrictions. Increased home equity also plays a part, if house prices fell considerably, perhaps that confidence would change. 

steampowered

Over a 10-15 year time period, you are almost certainly going to be better off investing through a stocks & shares ISA, rather than overpaying the mortgage.

You say that you have a low tolerance for "risk". However, it is important to be clear what sort of risk we are talking about. I believe your post focusses on "investment risk", meaning the risk of stocks & shares going up or down. But you also need to think about "inflation risk" - the risk of inflation eroding the value of your savings. And you need to think about "shortfall risk" - the risk that you won't have enough money to do what you want to do, retire at 60.

While stocks & shares provide some investment risk, over a 10-15 year period, this is pretty small. Stocks & shares will reduce your inflation risk and shortfall risk, when compared to cash savings or mortgage overpayments.

This graph provides a helpful illustration: https://www.nutmeg.com/nutmegonomics/increasing-your-chances-of-positive-portfolio-returns-the-facts-about-long-term-investing/

A mixed approach of some overpayments and some S&S ISA contributions is also fine.

stuart746

steampowered said:

Over a 10-15 year time period, you are almost certainly going to be better off investing through a stocks & shares ISA, rather than overpaying the mortgage.

You say that you have a low tolerance for "risk". However, it is important to be clear what sort of risk we are talking about. I believe your post focusses on "investment risk", meaning the risk of stocks & shares going up or down. But you also need to think about "inflation risk" - the risk of inflation eroding the value of your savings. And you need to think about "shortfall risk" - the risk that you won't have enough money to do what you want to do, retire at 60.

While stocks & shares provide some investment risk, over a 10-15 year period, this is pretty small. Stocks & shares will reduce your inflation risk and shortfall risk, when compared to cash savings or mortgage overpayments.

This graph provides a helpful illustration: https://www.nutmeg.com/nutmegonomics/increasing-your-chances-of-positive-portfolio-returns-the-facts-about-long-term-investing/

A mixed approach of some overpayments and some S&S ISA contributions is also fine.

Thanks, that graph is very helpful and something I had not seen before.
Yes, it is about investment risk (or loss aversion), but you are right I had only thought about loss aversion in nominal terms (the value) as opposed to adjusting to inflation. I am concerned about shortfall risk, but running the projection numbers through my DB pension forecast at age 60 I realise that is unlikely to be a problem.
All this is helping my decision-making enormously, even if only to improve the chances of making a rational decision over an emotional or psychologically biased one.