Should You Pay Off Your Mortgage Or Invest?
If low interest rates have lowered your mortgage payments, what should you do with the extra money? Should You Pay Off Your Mortgage Or Invest? Interest rates have been at rock-bottom for a long time now and many people are taking advantage of this opportunity to make over payments on their mortgage. Reducing your debt may seem like a no-brainer but there is an argument that investing is a better use of your spare cash.
The right course of action depends a great deal on your circumstances and your attitude to risk. To help you decide, we have broken down each side of the argument.
Saving and investing
Some homeowners are putting the money freed up by a cheap mortgage into other investments. The aim of this is to generate returns large enough to pay off the mortgage more cheaply in the long run.
A high-interest savings account – Your current savings account may not be giving you the best possible returns. Shop around to find an account or an ISA that generates a net return that is higher than the interest on your mortgage. However, taxpayers will need to take income tax into account.
A high-interest bond – Investments such as retail bonds have gained traction over the last couple of years. The premise is that you lend money to a company for a fixed period and they pay you an agreed rate of interest and give your capital back at the end.
However your capital is at risk and this strategy also requires an upfront sum which could be a limitation for some people. Remember also that income from a bond is taxable if you are a taxpayer.
Invest – Mathematically speaking, creating an investment portfolio is likely to generate higher returns than overpaying your mortgage if you have a low fixed rate mortgage, although this is not guaranteed. Taking higher risks may yield a higher return in the long term, however it’s likely that you’ll see more volatility in your investment.
Investing is also a long-term proposition. As a rule of thumb, you should be thinking about investing for at least as long as you’ve got left on your mortgage term, with 3-5 years as an absolute minimum.
Overpaying your mortgage
Making voluntary overpayments on your mortgage means that you pay less interest overall and clear your debt earlier. One potential catch is that some lenders charge overpayment fees although most allow you to overpay by up to 10% of the outstanding debt.
Another risk is that your lender could lock you into higher payments by reducing the term of your mortgage. You should be meticulous in analysing the fine print to make sure you’re not liable for any nasty surprises.
So, what should you do?
The net returns gained, even on a high-interest savings account, are hardly worth the effort so if this is your preferred savings option, you should probably focus on overpaying your mortgage to bring down the overall repayment term.
If your approach is cautious and your main aim is to sleep well at night, paying down your mortgage might be the most sensible thing to do. For higher-risk savers and investors, the gains may well be worth it in the long term.
As with all investing, your capital is at risk. ISA rules apply. Tax treatment depends on your individual circumstances and may be subject to change in the future.
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