Should you pay off your Mortgage or Invest?
Before you begin thinking about investing or paying off your mortgage, we recommend you have emergency cash available to cover 6 months of living expenses and pay off any high interest debts first. Assuming that you have done this, here are our thoughts to help you decide whether it makes sense for you to invest or pay off your mortgage.
Benefits of paying off your mortgage
- **Guaranteed tax free return–**your return is at the rate you pay your mortgage. So if you have a mortgage where you pay 2% interest, then you can earn a 2% tax free return by overpaying on your mortgage.
- Beat saving rates – With savings rates so low, it is virtually impossible to find deals that will save your more money especially as the income will be subject to tax once you have used your personal savings allowance.
- **Peace of mind –**being mortgage free for most people reduces anxiety as don’t ever have to worry about your home being repossessed should your circumstances change and you are not able to make your monthly payments.
- Reduce cost of living– for most people, their mortgage is their largest monthly expense. Reducing this down to zero, gives you a lot more money leftover at the end of each month.
- Flexibility– the lower your mortgage, the more control you have over the lifestyle you live. With lower commitments, you may choose to go part time, take a less well paid job that you love, travel more, start a business, retire early etc.
- Access to better mortgage deals – lenders provide better deals to those who have more equity in their property, known as ‘loan to value’ (LTV). This refers to the amount you borrow versus the value of your home. By overpaying your mortgage, you are reducing the amount you owe and hence your LTV. If you are able to overpay and go below one of the lender’s thresholds then you are more likely to get better mortgage deals and save even more money when you remortgage.
- More equity in your home– you own more of your home and can benefit from a rise in your home’s value. This can be used to release cash should you wish to down size your home or have access to funds in the future via equity release.
- It’s easy– unlike investing which requires research, making an overpayment just involves making a bank transfer from your bank to your lender. You just need to be careful you don’t overpay too much and trigger their early repayment charge. Make sure you understand your permitted limit before you start overpaying.
- Pay now, save more– you save a lot more in interest if you overpay now than if you overpay later. Banks front load interest payments, so at the beginning of your mortgage you are paying a lot more interest. This allows the banks to earn their profit from you sooner. This is known as amortization, see this YouTube video from #homeceo to learn more.
- Plan for retirement– if you are approaching retirement, it makes sense for you to pay off your mortgage beforehand. It is not advisable to still have a large mortgage when you are no longer earning an active income.
Benefits of investing
- Can earn higher returns– long term investments in an ISA allowance could earn you tax free returns that exceed the rate of return that you earn on repaying your mortgage more quickly. If interest rates then rise, you can use the return on the investments to help pay off your mortgage later.
- More liquid– many investments such as stocks and bonds are easy to sell, in case the asset class is not performing well or because you need access to cash quickly. However, selling your home which you need to live in is most definitely not. It is time consuming and expensive to sell and find a new home.
- More diversified portfolio– there is plenty of choice on where you decide to invest and it is recommended that you have a diversified portfolio. Whilst diversifying does not guarantee against loss, it can help reduce the impact of volatility and isolated risks. Only paying off your mortgage, means that you heavily exposed to real estate. If your property value goes down, this will have a more significant impact on your overall net worth.
What you decide, really depends on your attitude to risk, your understanding of investments and your ability to invest consistently, rather than just leaving excess cash sitting in low interest saving accounts. If you like the idea of reducing your living expenses and earning a guaranteed tax free return, then paying off your mortgage makes sense. If you are comfortable with investing and confident you can consistently earn a higher rate of return in the long run than paying off your mortgage then it makes sense to invest. You can then pay off your mortgage later using the money you have earned from investing. If you can afford to do so, it may make sense for you to do both, helping you to further diversify your risk.