Should I overpay my mortgage or invest?

Rob Morgan is chief investment analyst at Charles Stanley.

Homeowners with a mortgage are constantly faced with a financial dilemma: use excess money to pay off the debt or invest instead?

It’s a simple question, but the answer really depends on personal circumstances: age and job status, loan terms and interest rate, and most importantly, whether you’re a risk taker or more risk averse.

Rising bills and financial pressures mean that not everyone has money to spare right now, but if you do now or in the future, let’s take a look at some of the things to consider and some questions to ask yourself when making a decision. making a decision.

Paying off your mortgage: Safety first?

One thing is certain, you will save thousands of dollars in interest by paying off your debt faster.

Mortgage payments consist of two components; interest on the loan and a “principal amount” that is used to pay off the outstanding balance.

The longer you have the mortgage and the higher the interest, the more interest you pay. This is especially true in the early years when the loan balance is greater and you pay proportionally much more in the interest than the capital.

But overpaying your mortgage — paying more than is necessary under the terms of the loan agreement — incurs “opportunity costs.”

In other words, if you had invested the money, could you have made more returns than the interest on the debt?

With a higher mortgage interest rate, there are demonstrably fewer opportunity costs. It’s one thing to improve a 2 or 3 percent interest rate with investment returns, but it’s much harder to consistently hit more than 6 percent.

The higher the interest rate, the more logical it makes sense to pay off debts as quickly as possible. Therefore, high-interest debt, such as credit cards or personal loans, should be repaid with priority.

However, there may be such a thing as “good debt.”

High inflation can mean that your debt is wearing down relative to prices and your income, provided you keep making repayments.

Meanwhile, the current environment of rising interest rates worries many mortgage holders, but much depends on how interest rates move in the future, not just the coming years.

If inflation and interest rates remain high over the medium to longer term, it probably makes sense to reduce debt.

However, it is also possible that interest rates are falling sharply and that the cost of mortgage debt has returned to the low level of the past ten years.

The good news is that inflationary pressures appear to be easing. When clear evidence emerges that these are on a moderating trend, central banks can ease rising interest rates to contain runaway prices.

Those applying for a mortgage now, as well as those with variable rates, may face an uneasy period of higher repayment costs, but this could ease in the medium term.

If you decide to pay off or pay off a mortgage, you should take any penalties into account.

Early redemption fees often apply during a fixed or discounted period and are usually calculated as a percentage of the amount you repay.

Often these are layered and fall away over time.

Depending on the circumstances, it may be worth paying an ERC as the interest savings may be more than the fee incurred.

My verdict: While many people consider it an inferior route from a mathematical perspective, prioritizing a smaller mortgage over investing can make your financial position more resilient.

It can give you more control and more options, and it can reduce the fear of an uncertain future.

And when you overpay your mortgage, the debt shrinks and you have more disposable income, which can help fund premiums for pensions or other investments.

Investing your extra money: prioritize your pension

Building wealth over decades by allocating capital to well-managed and growing companies has historically been a reliable way to grow wealth.

However, to fully harness the power of the stock market and take advantage of compound returns, you need to leave your money invested for a long time – a bare minimum of five years, but ideally decades.

A major factor that can tip the balance sheet in favor of investing rather than paying off your mortgage is whether you can gain a significant advantage on the money you put in.

This is where the use of a pension scheme really stands out. Pension contributions benefit from tax relief that can ‘inflate’ your return.

Base-rate tax relief, for example, adds 25 percent to the value of your pot, and for higher-rate taxpayers, there’s an even bigger boost.

If you have access to a company pension, your employer also contributes, making it a very cost-effective way to save for retirement.

This should be maximized as much as possible before investing elsewhere.

Some investors use this strategy to pay off their mortgage, but you should keep in mind that money in a pension is not accessible until a minimum age has been reached.

At the moment there are 55 for personal pension plans, but that will increase to 57 in 2028.

Also keep in mind that pension rules and tax credits may change in the future. The longer you have to invest, the more beneficial the investment route can be, especially when it comes to pensions.

My verdict: If you like to take risks, building investment returns over long periods of time and investing as much extra money as possible can be a hugely powerful force.

That’s provided your investment strategy is sound and you have a long enough runway to handle the inevitable volatility markets.

Paying off too much on your mortgage or investing? It’s not just about the math…

The answer to this dilemma does not necessarily lie in a spreadsheet.

While investing can yield higher returns than the cost of interest on a loan, markets also carry the risk of losses. That uncertainty is a factor in itself.

The peace of mind of lowering mortgage payments and not having to worry about financial market performance can outweigh the potential benefits of investing.

If your general finances are in order — essentially you have no other high-interest debt to pay off and you’ve built up an emergency fund of about six months of spending — both strategies can work well.

You can also split the difference and overpay your mortgage while putting more money into your investments, ideally through a pension.

Final Checklist: What to Look for Before Making a Decision?

Your age: The longer you have to invest, the cheaper it can be. Younger investors typically have decades ahead of them, meaning they can take on more risk in search of higher returns.

However, those looking to pay off the mortgage in the run up to retirement don’t have that long, so they’re more likely to be mistaken on the safety side.

Your job status: If you have a steady job with good prospects of earning more money in the future, you probably have more confidence in rising mortgage rates.

Those in less secure employment or self-employment may want to lower the interest burden and pay off the debt faster because the outlook is less certain.

Your mortgage conditions and the interest: Those who have taken out a mortgage interest rate close to or below current interest rates are in a favorable position.

However, if you’re re-mortgaging or moving from a fixed to a standard variable rate, and therefore facing a sudden jump in payments, now may be an opportune time to pay off some of the debt to get things done. make it more manageable.

The higher interest rate on the debt represents a higher hurdle to investing that money instead.

If you have a fixed rate: There are often penalties for paying off portions of a fixed-rate mortgage, so check the terms carefully.

Those who were locked into flat rates at the beginning of this year or earlier probably got a very competitive deal compared to the rates available today, but think about when your repair will be done and what you’ll be doing at that point. especially if it is a shorter term of two or three years.

Are you a risk taker or more risk averse: If a financial decision causes you to lose overnight with worry, take the safe option.

Never put yourself in a vulnerable position if you can avoid it.

The feeling of a smaller mortgage and lower repayments can in itself be a reason to pay off debt, even though investing can be more financially rewarding in the longer term and the path those who can afford it choose to take the risk. to take.