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over pay the mortgage or save and invest?
WSA adsense code -->I mentioned earlier that now that the economic climate has shifted somewhat since I bought my house 18 months ago (yes, I’m a poor soul in negative equity) I should re-evaluate whether it’s better for me to overpay my mortgage or save and invest instead.
assumptions
The basic assumptions I’m going to run with (because they are true for me) are that:
- there is no consumer debt
- there is a fully funded 3-6 month emergency fund
- there is extra money in the budget without a purpose
key interest rate details - short to medium term
If I’m thinking about the short to medium term, then the only choice is deciding between a savings account and the mortgage. More risky investments are not appropriate on these timescales
- Mortgage interest rate 4.69% (Nationwide Base Mortgage Rate)
- Regular Savings account rate 5% after tax (Barclays Regular Saver Account)
- Cash ISA savings account rate 4.6% untaxed (Scottish Widows Cash ISA)
- Other savings account 3.64% after tax (Allied Irish Savings Account)
All these accounts are protected by the FSCS apart from the Allied Irish who are underwritten by a similar Irish guarantee.
arguments for and against
I calculated the amount of money that I could allocate to either saving, or overpaying. I then worked out how much that would grow to in savings, and how much that would reduce the mortgage balance by, over 3 years.
Assuming these rates stay about the same, the total difference between overpaying the mortgage or using a regular savings account or cash ISA is less than 1%. That’s really not a clear advantage. If I have regular money to put aside each month out of my salary, or haven’t used up all my ISA allowance it doesn’t make any real difference in financial terms if I put the money in a savings account, or overpay the mortgage. Even if I’ve used up my cash ISA allowance, and the money is irregular, or a lump sum, the difference between the overpaying the mortgage or saving is less than 2%.
Overpaying the mortgage means that the money cannot be accessed if needed for another purpose. It is less flexible than using a savings account. Whilst there is a psychological benefit to watching the mortgage balance decrease more quickly, I think I could achieve the same effect by mentally designating a separate regular savings account as the *mortgage overpayment account*.
There is very slightly less hassle associated with going for the mortgage overpayment as savings account rates need to be reviewed at least once a year to make sure you’re getting the best deal. However, since my other accounts and financial products also need to be reviewed once a year, I’m not sure that it’s too big a problem to add another account to the mix.
what about the long term?
Well, long term isn’t my forte. If, in the short term it doesn’t make that much of a difference whether to save or overpay, then in the long term the question is really about whether over the next 10-30 years I think the stock market will have a better than 5-6% annual return (the likely interest rate of my mortgage). For me, the answer to that question is probably. I expect my return from the stock market over the long haul to be in the region of 7% per year.
Whilst that 1% might not sound like it’s going to be lot, over the course of the remaining 28 years of my mortgage, and by the miracle of compounding, it would add up to 30% more money by investing rather than saving or overpaying. That’s a lot of money to turn down.
I mentioned the other week that I’d sort of thought that at some point I might want to live abroad. I don’t know if that’s something that I really want to do, or not, but I think that it’s fairly likely that in the next 3-5 years I may want to make some changes to my life. Although I’m settled, I’m not quite ready to say that for definite all my extra money can be tied up for 10 years.
Similar Posts:
- saving and investing in a low interest era
- choosing a savings account
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Tags: Discussion
9 comments for “over pay the mortgage or save and invest?”
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We overpay an average of $120 a month. I just looked and we’ve paid off 7 years of our mortgage in 4 years. I think that is worth doing. We plan to live here for the rest of our lives so I do hope to get the house paid off sooner rather than later.
I like what Ashley suggested. You could do both!
A lot depends on what you’re looking to accomplish and how performing either of these activities will achieve that goal.
If you’re sick of the mortgage vs looking to increase your net worth, for example.
What a good post. If I was in that position, I would probably chose to save the extra money until I had 9 or 12 months expenses in an account and then I would put it into overpaying.
@Ashley:
I’d certainly be happy living in this house forever, but I’m not sure whether I will or not - 28 years is a long time. The years that come off the mortgage are at the end, and they are a very long time away. But if I put the money aside in savings, I should be able to pay off a big chunk of the mortgage in a few years time, whilst keeping more cash on hand during the recession.
@Ron:
One of the problems is that house prices probably haven’t finished dropping - getting out of the negative equity (and so increasing my net worth) is a bit like chasing a moving target at this point. I might be sick of the mortgage already, but I’m nowhere near close to being able to pay it off in the next 3-5 years.
@Frugal Trenches:
Having a bigger emergency fund is definitely an advantage to savings that I really would appreciate.
Hi plonkee.
Have you considered the tax implications of overpaying. Overpayments get you a “return” tax free, so you really should compare only with other tax free accounts: ie ISAs.
The best ISA around now is about 4%, so if your mortgage interest rate is higher than this, shouldn’t you overpay as much as you can, as quickly as you can (assuming that you have an emergency fund, have no consumer debt etc).
um. yikes. I see that your interest rates up there are post-tax, so I guess you have taken it into account!
I did but I only just remembered at the last minute. Very important to compare like with like - thanks for reminding everybody
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As pcloon says you have to consider tax. I don’t know what you’re earning, but my cash savings are taxed at 40% as a higher rate tax payer in the UK. That will change things considerably.
There’s also a psychological advantage to paying off the mortgage early.
Then again I’m so debt-averse I have avoided buying a house until I can do so with cash! (Still saving, bear market hasn’t help!!
)
I’m not a higher rate tax payer yet, so that’s not as much of a problem. 40% marginal tax makes a big difference to the results.
For me, the fear of being without ready and liquid cash is greater than the desire to pay the mortgage off - particularly as I can’t pay the mortgage off for more than a decade at the very least.