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Many home-owners love the idea of being mortgage-free. After all, your mortgage is likely your biggest monthly outgoing, possibly representing over £1,000. British people, in particular, often love the idea of owning their own property outright – free from obligations to a bank. Yet from a financial standpoint, is it better to focus your earnings on repaying your mortgage, or towards investing in your future? Do you arrive at a stronger financial position by overpaying a mortgage or by putting extra money into a portfolio? Here at Hanson Financial Services in Liverpool, our team offers some answers below.
The simple answer
From a financial standpoint, the answer to whether you should focus on paying your mortgage or investing comes down to a simple question. Is your loan interest rate lower/higher than your expected rate of return (after tax)? A straightforward example can show what this means.
Suppose you have £10,000 in credit card debt with an APR (annual percentage rate) of 20% (just under the APR average in 2021). Assuming you do not repay any of the debt, you would be facing £2,000 per year in interest that you need to pay the bank – in addition to the principal. You wonder whether you should repay this debt or start an investment portfolio instead. However, to reach after-tax returns which beat 20% will require investing in very high-risk companies/assets, which are far from guaranteed. As such, in this scenario it is almost always best to focus on repaying the credit card debt before making significant contributions to an investment portfolio.
With a mortgage, however, the decision can be more complicated. First of all, a mortgage is a different type of debt to a credit card or personal loan, since a mortgage is a loan tied to an asset (whilst the latter are not). Secondly, mortgage interest rates tend to be much lower than the rates on credit cards. Whereas the latter in 2021 may be over 20%, for instance, the former could be closer to 2% – a much lower benchmark for your investments to beat.
Focusing on your mortgage vs. investments
If choosing between repaying a mortgage and investing was simply a financial question, the answer would likely be to prioritise investing. After all, with the right investment strategy you can likely generate returns far better than the 2% interest rate on your mortgage. However, this question is rarely just a financial matter. Rather, it is tied up with values, emotions and dreams for the future. These are also important and need to be brought into your decision-making.
For instance, perhaps one of your overriding values is to live with as little indebtedness as you can (perhaps because you do not like the idea of being “beholden” to anyone). This might lead you to prioritise repaying your mortgage as soon as possible. Another important factor may be your desired lifestyle. Perhaps you dream of changing careers, which would mean taking a significant pay cut. If, at present, you have large mortgage repayments to meet, then this may not be viable right now. Assuming you wish to stay in your home, therefore, it may make sense to focus on repaying the mortgage so your future monthly outgoings are lower – thus allowing you to make the career/lifestyle change.
Another area to think about is whether you can get a better rate on your mortgage. In 2021, the base rate is at an historic low of 0.10% (at the time of writing). As such, remortgaging could let you save £100s per month – e.g. by moving from your bank’s SVR (standard variable rate) to a good fixed-rate deal, which typically offers a lower rate of interest. These savings could then be committed to overpayments on your mortgage, or towards an investment portfolio.With these caveats in mind, however, there is still a strong case for choosing to invest rather than overpaying your mortgage. For instance, suppose you have £200,000 left to pay on your mortgage over the next 25 years at a 2.5% interest rate. By overpaying at £200 per month, you could expect to save £17,367 in interest and repay your mortgage almost 6 years early. On the other hand, suppose instead you put that £200 into an investment portfolio which grew 6% per year (average) over the same 25 year period. By the time your mortgage matures, the pot could have grown to over £138,598 – earning £78,598 in interest. Due to the huge power of compound interest demonstrated here, homeowners should think carefully before focusing their disposable income on overpaying their mortgage rather than investing.
Are you interested in talking to a financial adviser about your pension, mortgage and investment planning needs? We’d love to assist you here at Hanson Financial Services.
Please contact us to arrange a consultation with our team – free and without obligation – to gain more clarity and peace of mind over your financial plan.
You can call us on:
Liverpool Office: 0151 708 7616
Manchester Office: 0161 401 0991
Chester Office: 01244 960 039Or email via: [email protected]