Should I invest or payoff my mortgage?

The decision whether to invest or pay off mortgage is an interesting balance of different factors. There is the purely monetary, mathematical answer, but importantly there is the emotional and willingness to take risk considerations. To start what are the advantages and disadvantages of investing and overpaying on the mortgage.

Use extra cash to overpay on a mortgage:Investing the money:
Advantages
  • Mortgage free or will be mortgage free quicker
  • Save interest that would have been paid to the lender
  • Increased equity in your property
  • If investing in the stock market your money could be more easily accessible and used for your retirement income in the future or available for emergencies
  • The potential for your money to grow in value over the long term
  • Tax incentives or credits for retirement savings or other forms of investing
    Disadvantages
    • You may be charged a fee by the lender for early repayment
    • Money tied up in property
    • Money can’t be used on other things in the future unless you sell your property
    • Your money could be worth less if property prices fall
      • Investing is risky, you may see the value of your money fall
      • Your mortgage debt remains and you still need to make repayments

        Using circumstance for an average household here is a worked example that shows the financial consequences of overpaying 10% of the outstanding debt on a property. With an outstanding debt of GBP 200k with 20 years remaining and an annual interest rate of 3.5% on a repayment mortgage overpaying £20,000 has the following impact. Overpaying would save £17,979 in interest, and means the debt is paid off 2 years & 8 months earlier. If you would face a large penalty for overpaying, consider reducing the term of your mortgage, for a small fee. This increases your monthly payments, in effect permanently overpaying.

        Alternatively, here is a calculation of the tax credits of benefits from investing in a retirement pot. Your pension provider will claim back basic rate tax at 20% from HMRC adding this to your pot. If you pay a contribution of £80, your pension provider claims back a further £20 so a total gross contribution of £100 is paid into your pension pot. If you’re a higher rate taxpayer, you can claim further tax relief (at your higher rate less the basic rate already claimed on your behalf) from HMRC. This is usually claimed through your self-assessment tax return, although HMRC may also adjust your tax code to give you this additional relief. This means that if you pay income tax at 40%, you could claim an additional £20 tax relief, making your net contribution £60 in the above example.

        If you’re a UK taxpayer, in the tax year 2018-19 the standard rule is that you’ll get tax relief on pension contributions of up to 100% of your earnings or a £40,000 annual allowance, whichever is lower

        A £20,000 contribution to a pension has the following tax credit and growth at conservative growth estimates. The tax credit, non-taxable growth makes retirement saving very efficient in the UK.

        Contribution to pensionBasic rate tax at 20% from HMRC adding this to your potHigher rate tax relief through self assessmentTotal reliefTax relief for Basic Tax Payer plus growth over 20 years on £20,000
        £20,000£5,000£5,000£10,000
        20 yrs growth @3%£45,153£54,183£9,031@3% pa for 20 years
        20 yrs growth @5%£66,332£79,599£13,266@5% pa for 20 years

        The option to invest or overpay into a mortgage is a decision to reduce debt versus earn profits from investing. Investment maths often tilt in favour of maximising tax deferred investing opportunity before paying off the mortgage.

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