Overpayments vs S&S ISA (20 year period)

mameha · 12 September 2018 at 11:10AM

I want to check my maths/logic is correct regarding investing in a stocks and shares ISA rather than doing overpayments.

CURRENT STRATEGY
I am paying £780/month mortgage (repayment, 31 years left).
In addition, I pay £220/month as overpayment.
The overpayments save me 1.6% interest (currently), over the term would save £16000 in interest in total. In 21 years the mortgage would be paid off.

NEW PLAN

Instead of putting that £220/month into overpayments, I put it into a Stocks and Shares ISA (e.g. FTSE 100 index tracker), for the next 21 years.

RATIONALE

Average growth of FTSE 100 = 5%
Average growth of S&P 500 = 9.8%
These are far better returns than the 1.6% mortgage interest saved.

According to a compound interest calculator this results in a better return by £32235 after 21 years:
- S&S ISA = £98162 (55440 paid + 42722 interest at 5%)
- Overpayments = £65927 (55440 paid + 10487 interest at 1.6%)
- £98162 - £65927 = £32235

I then realised this is why people get an 'interest only' mortgage, as the return would be even greater.

Am I missing something here? Is my maths wrong?
I know that you get some bad years where the index drops 30%, but over time it always works out as growth. The only problem I can see with this plan is that there might be some colossal disaster and markets are down double digits for ten years or so, but this has never happened before.

Linton · 12 September 2018 at 1:15PM

I have not checked your maths but your general approach is fine - as long as your investment return exceeds your mortgage interest rate you gain by investing rather than overpaying. The problem is risk. Is your interest rate guaranteed for 21 years? At the moment interest rates are about at their lowest rate ever. Supposing it went up to say 15%? What happens if the colossal disaster happens in year 19? At some point it is likely that your investments will drop by 40% - would you have the courage to stay invested for the rebound rather than sell everything and crystalise your losses?

So I would hate to take that risk with an interest only mortgage. However the decision to invest rather than overpay a repayment mortgage makes a lot more sense. Note that this is sometimes discussed and the same conclusion reached on the Savings and Investment board.

mameha · 12 September 2018 at 1:34PM

Thanks, yes I have considered the interest rate, rises thing. That's the scenario where I could lose, if rates go up to say 5% and at the same time the markets are flat or negative, there would be pressure to bank the losses and start paying the mortgage. If that happens 10 years down the line it would be fine (I could simply close the ISA and move all the money into the mortgage), but if this happens in short term I would make a loss. But thats the risk taken for a potential (and probable) return of 30K at the end of the term.

Also if things are looking good around year 15 one can always change the investments to something more stable, or reduce/close the investment, to avoid any last minute market crash.

As I am not on interest only mortgage worst case scenario is I lose 100% of the 220/month investments and just finish off the mortgage in 31 years instead of 26. (To lose 100% would probably mean armegeddeon its not a realistic scenario, something like a 30% loss would be incredibly unlucky but a realistic worse case)

TrickyDicky101 · 12 September 2018 at 1:36PM

Congratulations! You've just built yourself an effective low cost endowment product (without the life insurance)!

Overpayments = return guaranteed.

S&S ISA = return not guaranteed (but potentially much larger).

It's an investment decision you need to make.

dunstonh · 12 September 2018 at 3:06PM

RATIONALE

Average growth of FTSE 100 = 5%
Average growth of S&P 500 = 9.8%
These are far better returns than the 1.6% mortgage interest saved.

S&P500 has performed much higher than typical in this growth cycle. However, it underperformed global markets in the previous cycle. FTSE100 is a dire index that is costly bottom or near bottom of comparable western markets.

The sterling decline has impacted on US equity returns in sterling.

I know that you get some bad years where the index drops 30%

About 45% potential on the UK equity (twice in the last 20 years it fell by 43%. The US equity is just over 50%. So, you are being a bit short on your downside.

I can see with this plan is that there might be some colossal disaster and markets are down double digits for ten years or so, but this has never happened before.

Yes it has. Just look at Japan. Or look at the FTSE100 which is not far off where it was back in 1999 or 2007.

mameha · 12 September 2018 at 3:49PM

Yes that would hurt if theres 20 years of no growth and at same time interest rates creep up.

Is there any similar alternative idea? For example until now I have been using 'regular saver' accounts at high street bank to put away £250/month in return for fixed interest 3%. That 'wins' vs overpayments but not by much. If there was a way to get a 5% guaranteed or very low risk that would be a sure winner. I see these mutual funds that invest in bonds etc and claim to be low risk but looking at the history they seem to experience losses from time to time too.

sal_III · 12 September 2018 at 3:59PM

This boils down to a choice between no risk (mortgage over-payment) and some risk (S&S ISA) investments. The returns are somewhat indicative of the risk. It's up to you to decide what your appetite for risk is.

Your mortgage is essentially a low return / low risk investment in you, by your lender. Ask yourself the question why don't they put all their capital in stocks&shares if the return is so good.

MallyGirl · 12 September 2018 at 4:01PM

there are several RS that pay 5%

MallyGirl · 12 September 2018 at 4:08PM

I am choosing to invest in S&S ISA rather than pay off the mortgage - in fact the flexible offset mortgage is actually increasing a bit at the moment as a result of aggressive pension and ISA contributions (making up for lack of attention to retirement in earlier years).

I expect to reach a peak balance in around 3 or 4 years once DD hits Uni at which point I will switch to a fixed rate deal for the last 5 or so years to retirement.
This is a safe enough plan for me as:
- I can stop paying in to ISA at any point if I want to bring the balance down again
- I am at 12% LTV on a £1m house

mameha · 12 September 2018 at 4:12PM

What is an RS?

Linton · 12 September 2018 at 4:16PM

mameha wrote: »

What is an RS?

Regular Saver account - high interest bank account with requirements/limitations provided by banks as a loss leader to attract customers.

Overpayments vs S&S ISA (20 year period)

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