What's the best way to repay a mortgage?

Mark_d

Suppose you take the starting point to be a repayment mortgage at 4%.

This should be the equivalent of an interest-only mortgage at 4%, plus savings yielding a net interest of 4%.

Rather than using ISA savings to repay the interest-only mortgage, if I used the 25% tax free lump sum from my pension, I would have benefitted both from the tax-free growth (equivalent to ISA) and also from not having paid income tax.  My mortgage is approx £250k so the savings I'd make would be significant.
Does this make sense to you?  An I misunderstanding something or have I stumbled upon a life changing idea?

Newbie_John

Not sure if you're asking or answering someone.. but I think that's the plan for many people - to use 25% tax free pension part to pay off the mortgage. Get the mortgage as long as possible, pay to pension as much as possible (especially if you're on 40% tax) and pay it off when you hit the retirement age.

The only issue I see is that the 25% threshold could be changed by government at some point.

Mark_d

kimwp said:

James Shack did an in depth analysis of this. Are you planning on your pension being in stocks and shares (sequencing risk) or a 4% savings (I have no idea if these exist for pensions, mmfs maybe?).

If you don't put your pension in stocks and shares, then you'll get pretty much the same value out as you put in (I think, due to inflation), so what you put into your pension will need to cover your retirement period. If you do put your pension into shares for the growth, then you are taking the risk that your portfolio plummets when you need to take a big lump sum to pay off your mortgage.

My pension is invested in a range of funds but I could invest all/part in cash/fixed interest securities etc.   The question was more about whether you thought the 25% tax-free lump sum was the best way to repay the mortgage principal on account of the fact that income tax would not have been paid on this amount.

Mark_d

Newbie_John said:

Not sure if you're asking or answering someone.. but I think that's the plan for many people - to use 25% tax free pension part to pay off the mortgage. Get the mortgage as long as possible, pay to pension as much as possible (especially if you're on 40% tax) and pay it off when you hit the retirement age.

The only issue I see is that the 25% threshold could be changed by government at some point.

It was very much intended as a question but I think you've answered it.  So thank you.

I'm nearly 20 years away from the end of the mortgage term but when I think it roughly lines up with when I can retire.

I have heard talk about potential changes to the tax-free lump sum.  I think it's highly unlikely this gets scrapped as it would affect many people trying to pay off their mortgages.  This is a risk though and I can mitigate it by maintaining just enough value in my portfolio to be able to repay the mortgage.  I don't need to grow the portfolio.

Newbie_John

Trying to do the total maths is tricky as value of the pension, mortgage rates, market conditions will vary across next decades.

If you assume all stays the same, let's say 4% mortgage, 4% safe investments like short term money markets, gilts - then the big savings come from not paying tax - your employer pays you £1000, if you're on 20% tax then you get £800 (£600 on 40% tax) which you could pay towards mortgage - but £1000 is saved in pension which then will go towards mortgage + the growth.

That could by why gov is after it as it's a decent loophole.

Peter_F

The 25% tax free lump sum has already been capped at £268,275 despite the removal of the Lifetime Allowance. In the absence of wholesale review of pension tax relief, I would suggest that this cap is likely to be reduced at some point.
There is no real logic behind having such a large tax free cash lump sum from a Government perspective.
The default position for mortgages on main residences is that they are arranged on a repayment basis. Interest only mortgages are generally limited to a few (more affluent borrowers). 
It would therefore be optimistic to assume that the lump sum would not be reduced because people are trying to pay off their mortgages. A more likely reason for it being retained is avoiding upsetting those in the public sector with large tax free lump sum entitlements. However the need to raise taxation levels may trump this at some point.
I myself was planning to use the lump sum to assist with paying my mortgage. Fortunately that time has now come but I would certainly not rely on it being around in 10+ years time.

MWT

Peter_F said:

I myself was planning to use the lump sum to assist with paying my mortgage. Fortunately that time has now come but I would certainly not rely on it being around in 10+ years time.

The other aspect to consider is that with a 20 year horizon there are a lot of assumptions likely to be made about the ability to continuously fund and grow the pension if it is not already at a significant value.

Income stream are not as certain as they once might have been, and the stock market has to be cooperative at the point in time when the funds are needed.

It is not for no reason that the lenders for the most part do not allow the use of the pension lump sum as a repayment vehicle these days. 

It worked well for me, but I would not advise my children to follow the same path.