A really common question I get asked from clients when they come into some money, whether that’s a lump sum or they have extra money coming in each month, is whether to pay off the mortgage or invest the new money.
When talking about investment this could be investing your money into the stock market, buying shares or investment funds. It could also mean buying an investment property.
Pay off the mortgage or invest: the advantages and disadvantages
So if you decided to use the extra cash to pay off the mortgage:
Advantages
- Mortgage free or will be mortgage free quicker.
- Save interest that would have been paid to the lender.
- Increased equity in your property.
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.
Let’s see how this compares to investing the money:
Advantages
- 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.
Disadvantages
- Investing is risky, you may see the value of your money fall.
- Your mortgage debt remains and you still need to make repayments.
Pay off the mortgage or invest: how to decide
There are two ways to answer this question. There is the purely monetary, mathematical answer, but more importantly there is the emotional and willingness to take risk considerations.
On a purely mathematical level and keeping the numbers simple let’s look at an example:
Outstanding mortgage is £10,000 and you have £10,000 available to pay off the mortgage or invest.
Mortgage rate is 3%, meaning interest payments are £300 per year.
You believe you can use your £10,000 to make a 6% return per year in the stock market, earning you £600.
In this example, by investing the money you are £300 per year better off.
So from a mathematical point of view the lower the mortgage interest rate and the higher the expected investment return it will make more sense to invest the money.
But there is a big BUT here…… can you guarantee that you will make 6% a year from the stock market? The answer is no you can’t guarantee that.
According to research from Barclays the average annual return for the stock market over the last 114 years is just over 5%. There have of course been years when the return was much higher and much lower.
This leads us onto risk. The risk you are willing to take with your extra cash. The no risk approach would be to pay off your mortgage. You are basically guaranteeing to save yourself the mortgage interest payments per year.
Investing in the stock market or buying another property is higher risk especially if you are thinking short term e.g. 10 years or less. Over the longer term you would hope that the stock market grows your money significantly but there is no guarantee of this.
You need to decide how much risk you are prepared to take and whether you feel comfortable building an investment portfolio that is going to deliver your desired returns.
Emotionally some people just love the fact they are mortgage free and it is a big milestone for them. There is nothing wrong with this even if the maths don’t add up. Far better to get on enjoying your life if you’re the sort of person that worries about investing.
What makes absolute sense is organising money priorities by paying off any other high interest debt like credit cards first. No investment is ever going to consistently beat the 20% interest you may be paying on credit card debt. It is also good to always have an emergency savings fund in case you have any sudden large expenses or lose your job.
What can really help when dealing with the question, pay off the mortgage or invest is to speak with an expert who will be able to guide you through the advantages and disadvantages and give you an independent assessment of what’s right for you.
Risk warning:
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.
