Should I Overpay My Mortgage Or Invest My Cash?
You find yourself with some extra cash at the end of the month – what are your options; purchase a luxury item? Invest your cash in stocks? Put your money in a savings account? Let’s explore what is the best option for you and your cash.
When you take out a mortgage, your lender will calculate how much your monthly repayments need to be to set at to ensure your mortgage is paid off at the end of the term. The calculation will take into account the interest rate of mortgage, the number of years you will be repaying your mortgage, and the amount you owe.
Making mortgage overpayments simply means paying more towards your mortgage than the amount set by the lender initially. This can either happen in the form of a recurring monthly payment, or as a one off payment. When choosing to overpay your mortgage at the end of the month, for example by £500, your full overpayment amount will be in capital, meaning no interest will be paid on this excess amount. Through overpaying portions of your mortgage, you can drastically reduce your mortgage repayment term, with the potential to save thousands in the process, due to saving on interest rates.
If you decide that mortgage overpayments are right for you, it is recommended to contact your mortgage lender. It is important to convey to your lender that you wish to make overpayments to reduce your mortgage term. With certain lenders, you will be able to change your mortgage payment online and arrange for a higher amount to be taken each month. The aim of overpaying your mortgage is to clear your mortgage debt more quickly, thus reducing the total amount of interest you will pay. As previously mentioned, it would also result in you being mortgage free much sooner.
Investing is the act of committing money or capital to an endeavor with the expectation of obtaining an additional income or profit. Investing is really about “working smarter and not harder.” Taking some of our hard-earned money and investing for our future needs is a way to make the most of what we earn. It is a way to set aside money while you are busy with life and have that money work for you so that you can fully reap the rewards of your labour in the future.
For the purpose of this article, we are going to hypothetically explore investing in a Tracker Fund, which is one of the most popular avenues of investment. First of all, what is a tracker fund? These are low-cost collective investment schemes that just follow the movement of an index. So when an index rises, the value of your fund rises with it, after incurring costs. Conversely, when the index falls, your investment in the fund falls with it, too. Trackers are known as passive investments because your fund manager isn’t making any ‘active’ decisions about markets or individual investments. Tracker Funds, in a sense, act as a middle man between the investor and the market itself.
That means managers of Tracker Funds need to decide how to deliver performance as close as possible to that of the index they’re following. They also need to manage events such as takeovers – which can change the composition of the index – and decide the best way to reflect those changes in the fund. So a Tracker Fund might not always hold all of the shares or bonds in the index. Nevertheless, owning all, or at least most, of the securities in the market is a good starting point for thinking about investing.
Benefits of a Tracker Fund
- One-stop shop: you can access entire markets with one investment, giving you a quick and easy way to implement your investment strategy.
- Diversification: our index funds often hold hundreds or even thousands of shares or bonds, meaning you are less exposed if one of the holdings performs poorly.
- Low research overheads: we’re not trying to beat the market, so we don’t have to pay lots of researchers to analyse companies. This means we can offer the funds at low cost, helping you to keep more of your returns.
- Economies of scale: because we pool lots of investors’ money together before we invest, we pay lower dealing fees – and we pass these savings on to you.
Drawbacks of a Tracker Fund
- The aim of index funds is to track the performance of a given index. They will do this if the index is going up or if it is going down, so you might get back less than you invested.
- Index funds don’t try to position themselves to make the most of the prevailing market conditions. If you favor this approach, an active fund might be more appropriate for you.
- Our index funds invest in a variety of markets which carry specific risks. These might include currency risk from investing overseas, or risks involved in emerging markets, smaller companies or derivative usage.
Dollar-Cost Averaging (DCA) is another entity of investing that is important to explore and consider. DCA is a strategy that allows an investor to buy the same dollar amount of an investment on regular intervals. The purchases occur regardless of the asset’s price. DCA is a tool an investor can use to build savings and wealth over a long period. It is also a way for an investor to neutralize short-term volatility in the broader equity market.
Investing Money vs Mortgage Overpayment
Since the recession of 2008, millions of people have been taking advantage of low interest rates in order to overpay their mortgage. Getting rid of your debt years early, as well as saving thousands on interest rates, seems like a sensible financial method, but there are other options to enhance your financial situation.
Firstly, it is important to remember that anyone with expensive forms of debt, such as credit or store cards, should pay off these debts before considering to overpay your mortgage. In addition, having an emergency fund, roughly the amount of 6 months income, is essential before choosing to either overpay or invest.
Deciding to overpay or invest comes down to your personality trait. If you are a risk taker with ambitions to make a high return on your investment, whilst acknowledging the potential for loss, then investing is for you. If you are risk-adverse however, you will find paying off your mortgage the safer option. There is a clear psychological burden of having debt, thus the relief when it has been paid off allows for a great sense of financial achievement. When paying down your mortgage, it comes with a guaranteed return of, for example, 2.5%, or whatever your interest rate is. Hence, there is no risk involved, and no chance of losing a penny.
Investing, on the other hand, involves a level of risk, but with much more attractive financial return. The market IS volatile, but with a good level of investment knowledge and advice, you will be able to ride the peaks and troughs of the stock market, while still making significant financial gain.
What would you end up with if you used your ‘mortgage overpayment’ funds to invest in stocks instead? It is too difficult to determine a fixed return amount, and all depends on factors such as the amount invested, how much risk you are willing to take, and how long you invest for. According to Barclays’ Equity Gilt study, you can expect to get returns of 5.6% over the long term from the stock market – although this figure is ‘inflation adjusted’ and so is lower than the headline figure would be. With investment, you must also be prepared for the dips in the market, which could leave you at a financial loss in certain months.
What is the right choice for you?
In the end, your decision is almost totally based upon your personality type. If you are risk-adverse, or stressed with existing debts, then overpaying your mortgage is certainly the most intelligent choice. However, if you believe the reward outweighs the risk with regard investing, then placing your extra cash in a Tracker Fund is the most viable option.
It is important to note the one thing that both investing and mortgage overpayment
We asked the experts
Interestingly within my family we have examples of both of these approaches! My partner and I have taken the approach of investing in ISAs while keeping our mortgage repayments at their normal level, whereas my sister and her husband have chosen to overpay their mortgage. I wholeheartedly agree that an individual must choose what feels right for them. As much as I would love to be mortgage-free, I personally prefer to invest in index funds because I hope in the future to live indefinitely off the interest/dividends using a 4% safe withdrawal rate concept.Corinna. Inspiring Life Design
Here’s what I would say ‘Conventional wisdom is to always repay debt so long as the interest rate on the debt is greater than that of the investment. However, this doesn’t take into account the compounding affect of the investment. Consider this; if you were considering overpaying the mortgage by £300 pm but we’re to invest it at 11% compounded (average FTSE annual growth) for 25 years, you’d have £477,174.’Perry, Stupid Is The Norm