What is better, overpaying my mortgage or investing?

With the Bank of England expected to cut interest rates this year, we have looked at some studies to see whether it is more beneficial to overpay on your mortgage or use that money to invest.

Making overpayments to your mortgage can be a smart move. However, the anticipated drop in interest rates may result in favourable mortgage rates, meaning that investing your extra cash will make your money work harder in the long run.  During this article, we will summarise the pros and cons of overpaying your mortgage and comparing this to saving interest with the amount that could be earned from investing.

Key considerations of overpaying your mortgage

By overpaying on your mortgage, you will reduce the amount of debt you owe which is appealing for the following reasons:

• Could get mortgage free sooner
• Less interest to pay overall
• Lower mortgage rate when it is time to remortgage again
• You will be less exposed if interest rates were to rise again

Potential drawbacks to overpaying on your mortgage:

• Normally, there are fees if your overpayments are more than 10% of the remaining mortgage balance, although this will vary from lender to lender.
• By putting money into your mortgage, you lose accessibility to it, unlike if it was in cash savings or an investment portfolio.
• Depending on your mortgage rate, the amount you’d save on interest could be lower than the amount you could earn from investing.

The lower your mortgage rate, the stronger the case for investing

Whether or not you will be financially better off from paying off your mortgage or partially investing all comes down to investment performance. The general note is that the lower the interest rate on your mortgage, the stronger the case for you to invest. Over the long run, you could potentially earn more from investments than the amount that could be saved in interest by overpaying on your mortgage.

Always remember, the value of your investments can fall as well as rise and you may get back less than you invested.

Overpaying a mortgage versus investing

We compared the savings from overpaying a mortgage with the returns from investing over ten years.

The calculation shows how much interest someone could save by making a £15,000 mortgage overpayment at the start of a 10-year term, assuming an outstanding balance of £250,0000.

Based on a five-year fixed rate mortgage of 4.59%, we found that someone could save £6,030 over a period of ten years. Based on a three-year fixed rate, the saving would be around £5,070.

Potential return from investing through an ISA

We looked at potential returns you could earn by investing £15,000 over 10 years into an ISA. By investing in an ISA, there is no tax to pay on income or Capital Gains or on any income or profits made.

Depending on the allocation of shares to bonds within the investor’s portfolio, Vanguard did some research and found that the returns would range between £11,060 to £11,980. This shows that after 10 years, you could potentially be £5,000 to £7,000 better off by investing in an ISA rather than overpaying on your mortgage.

Please note that these are projections and are not guarantees.

Potential return from investing through a pension

If you were to invest into a pension rather than an ISA, the returns could be greater due to the tax relief that personal pension contributions benefit from. An example of this is if you were to invest £80 into a personal pension, this would be boosted to £100 if you are a basic-rate taxpayer. Higher and additional rate taxpayers can claim an additional £20 and £25 respectively through their self-assessment tax return.

If you were a higher-rate taxpayer and you contributed £15,000 into a pension, assuming you claimed back the extra tax-relief and invested this as well, the contribution would be boosted to £25,000. Based on the research from Vanguard, as with the ISA, returns could range between £18,030 to £19,450 after 10 years, making you between £12,000 and £15,000 better off than if you overpaid on your mortgage.

However, it is important to bear in mind that should you invest into a pension, the minimum age you can access the funds is currently 55 rising to 57 after 6th April 2028.

What is the choice for you?

If you can commit your money for at least five years and are comfortable with the risks of investing, it may be worth considering this option.

However, what’s right for you will depend on your individual circumstances, including:

• Attitude to risk: how much risk are you willing to take with your money and how much can you afford to lose? Making mortgage overpayments is like getting a guaranteed return on your money, without any investment risk. Investing carries risk but has the potential for higher returns.
• Financial goals: what are your short, medium and long-term financial objectives?
• Potential cash needs: will you need easy access to your money?
• Mortgage details: what is your outstanding mortgage balance, credit score and current mortgage rate?

If you are unsure, feel free to get in touch. Our experienced advisers can help you evaluate your options and determine the best course of action for you.