Running the numbers - ISA vs mortgage overpayments

MoneyGeoff wrote: »

Get a better mortgage. If you can get a mortgage close to 1% then it becomes a no brainer to invest instead of overpaying.

Not very helpful.

Where, exactly, do you suggest the OP finds this magical 1% mortgage interest rate that will last for five years, and be available on buy-to-let (as this appears to be the kind of mortgage the OP has)? A quick google suggests that you might be able to get 3.99% on a five year fix for buy-to-let. If it is a residential mortgage, then I can see a deal for 1.8%, but that is still some way off your suggested 1% rate.

Oh, and even should this mythical 1% rate appear, it still isn't a, "no brainer" because the investment timeframe is so short.

Dunstonh's comments are worth taking notice of. Unfortunately, there aren't really any investments that will give you a reliable 4-5% over the five year period, as that's not really long enough for the markets to even out to get the good with the bad. When you are dripping money into an investment over a period of sixty months, some of it's invested for the full five years but most of it isn't and some of it is only invested a few months. So depending on timing and sizing of what you pay in, it might only be 2-3 years on average, that the total amount is invested for.

If you could just keep on waiting for the markets to recover, up to 10 years plus, that would be fine. You don't need to hit the exact 4-5% target on a specific day, just generally do better than the alternative opportunity (eg mortgage overpayment) over the long term.

Unfortunately it doesn't sound like you have the luxury of waiting 10-20 years for what sounds like the best path, to actually end up being the best path. If you want to move back into the property in five years, that's the point by which you want/need the investment to have been a success. If the investment /housing markets are well down, and if the reason for that is rapid interest rate rises, and you chose to invest instead of save, you could be hit with a triple whammy:
- investments down, so you can't pay off as much mortgage as you'd hoped;
- property value down, so mortgage is higher LTV than hoped (worse rate accordingly)
- interest rates generally up so you are back up to 5% instead of 2.7%.

As such, simply overpaying the mortgage at a known interest rate is not a bad plan (assuming you've already exhausted any practical opportunities to get better rates on cash from promotional current accounts /savings accounts).

kidmugsy wrote: »

Assuming that you have no other debt, and that you have a good cash emergency fund, the case for overpaying seems pretty reasonable to me. In essence you're going to be getting a tax-free interest rate of 2.89% with negligible risk. Depending on your tax position, doing it with an endless rolling-over of higher-paying regular savers might be even better, paying off the mortgage in lumps as the savers mature.

Looking at your own residential property it's true that an overpaid mortgage is effectively generating a 'tax free' return at whatever headline interest rate you save.

However, with BTL mortgage it's different. If you are paying a 2.9% interest rate on a chunk of mortgage that you have (because you chose not to pay it off early...), your business makes lower taxable profits, as you're allowed to deduct some of the borrowing costs. The amount you can deduct (if a higher rate taxpayer) is reducing each year as part of the phasing in of new regulations, but even by the 2020/21 tax year a higher rate taxpayer can still effectively get 20% basic rate tax relief on their mortgage interest cost, and a basic rate taxpayer isn't really affected by the new rules.

Basic rate tax relief achieved on the 2.9% interest paid (with the tax relief not achieved if you didn't have the mortgage) means that the effective 'profit' of overpaying the mortgage is only 2.1% a year on what's put in.

A 2.1% return on GBP cash might still be better after tax than your other cash or near-cash options, depending where you are in the world. But perhaps less exciting than the 'nearly 3% it first looked like.

thg wrote: »

. Essentially, perhaps I'm trying to be too clever and shave off a little bit of money, but probably taking too much of gamble, when I could get most of what I want to achieve by overpaying.

You have probably hit the nail on the head, in that a common mistake for people in the investment game is to feel you have been short-changed if you don't get the best return. Lots of people on here see other funds that they could have picked getting results better than the funds they actually picked, when markets are storming upwards, and are tempted into riskier options due to "fear of missing out".

As you mentioned in the opening post, this is ultimately an investment question rather than a mortgage one. When new investors post here about what their goals or objectives are, it is common to say they just want to "make my money work the best it can for me, I think I can do a lot better than cash", yet also "obviously with as low risk as possible, I've worked hard for the money and can't afford to lose it". And the problem is that these statements are pretty much irreconcilable, you typically have to take bigger risks to get bigger rewards but of course using big risks does not guarantee big rewards or they wouldn't call it risk!

So the sensible compromise for most investment planning is working out within your goals and objectives what you actually *need* as a bare minimum; and then what you would *want* if you could have it, and between those two extremes what would you *accept* to end up at and still be broadly happy because it was better than the worst acceptable position and didn't involve the high risk of shooting for the moon and missing.

It seems in your case you would achieve most of what you need by just plugging away with overpayments; to make small improvements you could use higher rate short term bank accounts (regular saver accounts etc) but only where convenient or available (might be less easy when traveling); and maybe you could do a small amount of investing on the side with a portion of the money you were going to overpay with- but investing the whole lot just seems like asking for trouble.

One further point on my earlier comment about whether the interest saved on BTL mortgage is really "tax free". Obviously you lose the 20% "tax shield" on your business profits that the mortgage interest would otherwise provide, but otherwise it feels tax free because it isn't really income, it's instead a saved expense. If you're overseas the practical position of how you make your money vs save your costs may be quite important -e g. the non-UK country in which you may acquire tax residency might or might not choose to tax your worldwide dividend income, interest income, capital gains etc, and it may or may not charge tax on your UK lettings business profits.