plonkee money an english-er's thoughts on personal finance

January 6, 2009

over pay the mortgage or save and invest?

Filed under: house — Tags: , , , , — plonkee @ 12:00 pm

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.

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