If you’re a homeowner with some spare cash and your monthly mortgage payments are low, should you start overpaying?
We all need a decent emergency savings pot and we should pay off our more expensive debts first, if possible. Then we have the luxury of deciding whether to overpay our mortgages, or save any spare monthly income we have.
Here are some tips to help you decide whether clearing your mortgage more quickly is the right thing for you.*
Can you overpay?
Look at your mortgage terms and conditions to see how much, if any, you can overpay at no cost. If the penalty is high, you should consider either investing your spare cash, or save it until that mortgage clause expires and you can overpay without penalty.
Watch this space though: there are plans to change the law in the next few years to reduce or outlaw penalties in most circumstances.
Does your employer offer a no-brainer?
Some employers match the contributions we make to a pension scheme, up to a specified level, which might be 5 per cent of your income, for example or more. Your employer effectively doubles your money immediately.
Although there are certainly downsides to pensions, if you are not taking full advantage of your employer's generosity, remember it’s essentially free money.
Overpaying is low risk/high reward
The faster you pay down debt, the richer you will be in the long run. Overpay £1 and you will save yourself the interest you would have paid on that pound of debt – not just this year, but every year till the end of the full mortgage term.
If you still have many years left, overpaying is a guaranteed way to improve your financial position – provided you don’t need the money you used to overpay for emergencies.
Investing is high risk/high reward
Invest that pound instead and you could turn it into £10, £20 or more by the end of the full mortgage term. In fact, so long as you invest in a diverse selection of shares, or in funds with low charges such as index trackers, and so long as you do not buy and sell too often (which costs a lot of money in charges and hidden costs) you could do reasonably expect to do at least as well as overpaying your mortgage, and quite possibly a fair bit better.
However, the higher returns of investing are not guaranteed. In the short term stock markets can plummet, and you can lose money even over long periods.
The most comprehensive and detailed study on global investment returns, by London School of Business professors Dimson, Marsh and Staunton, shows that the stock market as a whole can still show a loss over 20 or more years, when you adjust for inflation.
Even if it does not, it might not go up enough to justify the risk you took, and you might regret not overpaying your mortgage.
Are you confident?
Whenever you are assessing an investment opportunity, consider how much mortgage interest you could save instead during the time you will own that investment.
If you are very confident that your investment will trash the amount of interest you would save, you know what to do. If you are just a little confident, the risk just might not be worth it.
Bide your time
You could delay your decision while interest rates are low and put your spare money in cash ISAs and savings accounts. Then, when interest rates start to rise, you have the option to pay off your mortgage or to use the money for something else, if a better opportunity presents itself.
But do not forget your mortgage contract may limit your monthly or annual overpayments through penalties, so you might have to spread out your overpayments by starting them earlier.
*The content of this article does not constitute financial advice and is the author’s own opinion only
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