Today’s Blog is targeted at the lucky cohort of individuals would have bought their own home, albeit with probably a hefty mortgage from their bank, and who have some spare income or perhaps a lump sum that’s been saved up. The question is, do you save your extra cash, invest it or use it to overpay your mortgage?
Should I overpay my mortgage?
By overpaying your mortgage, you could potentially shave years off your debt, but that doesn’t mean it’s always the right choice, especially if you can find a good savings rate on the market. There’s also the option of investing your extra income into the stock market, where you could potentially obtain a better return, but this comes at a risk as shares can go down as well as up. The key question is, of course, which one to choose?
Saving versus mortgage pay-down
Overpaying your mortgage will give you a simple, safe and risk-free return by paying off your debt early, which will reduce the overall amount of interest you have to repay. The main potential risk is if your home drops in value and whilst this is unlikely, you would still need to pay off the debt in either case.
Cash held in a savings/ISA account provides a risk-free guaranteed return, so which option is best? For a start, there will be no noticeable difference to the long-term result if your interest from savings is at a similar rate as your mortgage. However, with the best savings rates hovering around 4 to 4.5% at the moment and the best mortgage rates at around 3.7% (APRC 6%) fixed for two years, there’s likely to be a modest benefit by repaying your debt, but there isn’t a huge difference between the two.
As the average mortgage rate is currently higher than the best savings rate available to you, overpaying is currently the better option. The bigger the difference between the two rates, the bigger the difference in outcomes, but bear in mind that other factors can affect which option makes the most sense for you. An example of this is the ongoing war in Iran, which has resulted in a rise in mortgage interest rates.
Investing your cash
Given the significant rises in both the US and UK stock markets in the last few years, the average stocks & shares portfolio has given a better return than either a savings account or overpaying your mortgage. But this approach does involve risk.
Over the long term, investing in stocks & shares has typically outperformed cash, with analysis by IG the world’s leading online trading investment platform, showing that, in the last 7 years, UK stock market investors have seen around seven times the real return of cash savers after taking into account inflation.
But be warned! Investment returns are not guaranteed and you could lose money, I remember clearly the 2008 financial crisis, when the stock market tanked. Since mortgages are also usually long-term investments, it’s fair to compare the two, but it’s not a perfect like-for-like comparison. Many people prefer the certainty of a savings account or mortgage overpayment, rather than the possibility of better returns on the stock market.
Market comparison
Assuming that you have a £200k 30-year mortgage on a 4% rate, with spare income of £250 a month, do you save in a high interest account or ISA, increase your payments to your lender or invest in the stock market. The best savings rates on the market are currently around 4-5%, whilst a 7% return on investment is an achievable expectation for an experienced investor, but which one to choose?
- Overpay your mortgage: This is the clear winner if you are risk averse and, assuming mortgage rates remain at or around 4%, you could repay your loan 8 years early
- Save £250 per month in a high interest account: Based on an interest rate of 4.5%, this will enable you to clear your loan 7 years early
- Invest £250 per month in the stock market: If you are prepared to take the risk, this approach, could potentially enable you to repay your loan nearly 10 years early
But remember, your mortgage rate is likely to change over the lifetime of the debt, as will savings rates and investment returns. But whichever choice you make, you can change your strategy at a later date as and where necessary. Also, you don’t have to go all in on one strategy and could employ a combination strategy of partly overpaying your mortgage, whilst also investing, either in savings accounts or the stock market.
Five other things to consider
- Do you have an emergency fund? : Before making a decision, make sure that you have some money tucked away, with the general rule being to have a minimum of 3 months’ worth of key outgoings saved in immediately accessible funds for emergencies.
- Will you be charged to overpay? : Many mortgage deals limit how much you can overpay without penalty’ with most lenders usually allowing penalty-free overpayments of up to 10% of the outstanding balance each year.
- Any other debts? : If you’re carrying debt on credit cards or personal loans, these normally charge much higher interest rates than a mortgage. So, clear this type of debt first, which will save you more money than overpaying your home loan.
- Overpayments can improve your loan-to-value. : In the examples above, a consistent interest rate was used across the life of the mortgage; but lenders generally offer better rates on smaller loan sizes. So, if you can reduce the size of your mortgage through overpayments, you may be able to secure a better deal when you come to remortgage at a later date.
- Will you pay tax? : Remember, you may need to pay tax on your savings interest if you go over your personal allowances and if you’ve gone into market investments, you may be liable for Capital Gains Tax, as the annual exempt amount is only £3,000 for individuals .
Also, do not forget that there’s no tax payable on the ‘savings’ you make by overpaying your mortgage.
Accountant’s view
Do not forget that it is very important to do your research before making a decision and, if necessary, take independent advice. Finally, my thanks go to those lovely people at Which (Money) Magazine whose article on 23rd February inspired today’s Blog.
Should you save, invest or overpay your mortgage?
Today’s Blog is targeted at the lucky cohort of individuals would have bought their own home, albeit with probably a hefty mortgage from their bank, and who have some spare income or perhaps a lump sum that’s been saved up. The question is, do you save your extra cash, invest it or use it to overpay your mortgage?
Should I overpay my mortgage?
By overpaying your mortgage, you could potentially shave years off your debt, but that doesn’t mean it’s always the right choice, especially if you can find a good savings rate on the market. There’s also the option of investing your extra income into the stock market, where you could potentially obtain a better return, but this comes at a risk as shares can go down as well as up. The key question is, of course, which one to choose?
Saving versus mortgage pay-down
Overpaying your mortgage will give you a simple, safe and risk-free return by paying off your debt early, which will reduce the overall amount of interest you have to repay. The main potential risk is if your home drops in value and whilst this is unlikely, you would still need to pay off the debt in either case.
Cash held in a savings/ISA account provides a risk-free guaranteed return, so which option is best? For a start, there will be no noticeable difference to the long-term result if your interest from savings is at a similar rate as your mortgage. However, with the best savings rates hovering around 4 to 4.5% at the moment and the best mortgage rates at around 3.7% (APRC 6%) fixed for two years, there’s likely to be a modest benefit by repaying your debt, but there isn’t a huge difference between the two.
As the average mortgage rate is currently higher than the best savings rate available to you, overpaying is currently the better option. The bigger the difference between the two rates, the bigger the difference in outcomes, but bear in mind that other factors can affect which option makes the most sense for you. An example of this is the ongoing war in Iran, which has resulted in a rise in mortgage interest rates.
Investing your cash
Given the significant rises in both the US and UK stock markets in the last few years, the average stocks & shares portfolio has given a better return than either a savings account or overpaying your mortgage. But this approach does involve risk.
Over the long term, investing in stocks & shares has typically outperformed cash, with analysis by IG the world’s leading online trading investment platform, showing that, in the last 7 years, UK stock market investors have seen around seven times the real return of cash savers after taking into account inflation.
But be warned! Investment returns are not guaranteed and you could lose money, I remember clearly the 2008 financial crisis, when the stock market tanked. Since mortgages are also usually long-term investments, it’s fair to compare the two, but it’s not a perfect like-for-like comparison. Many people prefer the certainty of a savings account or mortgage overpayment, rather than the possibility of better returns on the stock market.
Market comparison
Assuming that you have a £200k 30-year mortgage on a 4% rate, with spare income of £250 a month, do you save in a high interest account or ISA, increase your payments to your lender or invest in the stock market. The best savings rates on the market are currently around 4-5%, whilst a 7% return on investment is an achievable expectation for an experienced investor, but which one to choose?
But remember, your mortgage rate is likely to change over the lifetime of the debt, as will savings rates and investment returns. But whichever choice you make, you can change your strategy at a later date as and where necessary. Also, you don’t have to go all in on one strategy and could employ a combination strategy of partly overpaying your mortgage, whilst also investing, either in savings accounts or the stock market.
Five other things to consider
Also, do not forget that there’s no tax payable on the ‘savings’ you make by overpaying your mortgage.
Accountant’s view
Do not forget that it is very important to do your research before making a decision and, if necessary, take independent advice. Finally, my thanks go to those lovely people at Which (Money) Magazine whose article on 23rd February inspired today’s Blog.
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