Investing Vs. Paying Off Your Mortgage Early

By Neil Faulkner | 25 March 2008

I'm going to assume for this article that you're on course for retirement. (Follow my four-step guide to work out whether you are.) I'm also going to assume that you're not overstretching yourself with your mortgage. Finally, I'm going to assume that you have no other debts, except perhaps interest-free ones, or a student loan.

That's a pretty sweet position to be in. But what should you do if you're lucky enough to have some spare money as well? (By which I mean either a lump sum or spare monthly income after bills; it works for both.) Should you invest it in the stock market or pay off your mortgage early?

Look at your return

In order to justify investing rather than repaying your mortgage early, you need to get a return that beats mortgage interest rates. Otherwise your debt is costing you more than your investment is earning. So, if your average interest rate over the length of the mortgage is 6.5%, your investments, after charges and taxes, need to make 6.6% per year or better, on average.

Over short periods of time, anything can happen to the stock market. This means it can plummet. So you should invest only if you intend to do so for at least five years, preferably ten or more. Anyone who can't do this would certainly be wiser to pay off their mortgage early.

If you can invest for a long time, whether you should do so depends on your attitudes to money and risk.

Over long periods, the stock market has performed well. Over a hundred years or so it has gone up by roughly 10% to 11% per year, on average. However, in recent years - the past 25 for example - the increase has been just 7% to 8%. Factor in charges for dealing in shares (and possibly some tax, too) and what you get comes down some more.

Fool founder David Berger was in favour of investing rather than repaying a mortgage early. This is the man who successfully used fornicating monkeys in his Ten Steps guide to investing in order to make an important point about shares. So we should listen to him.

In his books and on this website, Berger used to repeat frequently: 'Small differences in investment returns matter. A lot.'

However, this goes both ways. If investment returns over the next few decades dip another percentage point or two, you might end up wishing you'd repaid your mortgage instead!

My view

Personally, I really like the idea of repaying my mortgage early. (When I stop travelling around and settle down long enough to buy a property, that is.) It's comforting, because the return is largely known. Once you've paid off your mortgage, that's it. There's no more interest to pay. You own your own home.

The most important word I used there is 'comforting'. Anyone insane enough to have clippings of all my articles on their walls will have gathered that I aim to be comfortable, not stinking rich. That's where I've set my expectations, and I can maintain my comfort right through to retirement with relatively little risk (and stress!).

What's more, if you pay off a mortgage early, you are guaranteed to save yourself thousands of pounds in interest payments. There is no such guarantee when it comes to returns on investments, despite what I said earlier about long-term trends.

So, for my comfort level, I'd like historical annual stock market returns to have been quite a few points higher before I'd be prepared to take a chance. Because I have a known return by repaying early, I find the risk to investing instead is too high for the reward. Even if (or especially because) small differences matter a lot.

What's your view?

However, many of you may prefer to take on more risk. Perhaps you also have great faith in your own investment abilities. That's all fine, too. Let's face it, if you're in the position where you don't know what to do with your extra money, it's not an extraordinary risk you're taking!

We have some great, related stories to read!

> Read more about how small differences in the average gain of your investments matter (a lot!) in: The Miracle Of Compound Returns. This article has a calculator to help you see how much your investments might grow.
> Read more about the savings you'll make by paying off your mortgage early in this excellent article by former editor Stuart Watson: Paying Your Mortgage Off Early. This article also explains more about the advantages of investing over repaying your mortgage early.

Tools and guides

> Compare mortgages.
> Track the stock market with an index tracker or with Exchange Traded Funds.

Comments

The opinions expressed here are those of the individual writers and are not representative of The Motley Fool.

At 06:40 on March 27 2008, jsrark said:

1 If you have some savings find and use an off-set mortgage; to me this is the best of both worlds. No tax on savings and less interest on borrowing. I know that you have to make some detailed calculations to find the best deal but for me this offers the satisfaction of overpaying themortgae and not paying tax plus at the end of the term the savings are still there.

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At 07:47 on March 27 2008, tonjt said:

I recently got a lump sum after being made redundant, and I had no hesitation in using it to pay off my mortgage. Yes, maybe I could earn more over the long term by investing the money in shares. But when you are talking about making sure you have a roof over your head, I don't like the word "maybe". A little extract from a book on "the science of poker" is perhaps surprisingly relevant here. It goes something like this: Mr Super Rich offers to pay you £500,000 on the outcome of a flip of a coin, if you are willing to risk your life savings of £100,000. You are getting 5-1 for your money on an evens chance. Would you take it? The author says: "Personally, I would tell Mr Super Rich to get lost! He may be offering me fantastic odds, but I just could not afford to risk everything I have saved over a lifetime on the flip of a coin." To my mind, gambling with shares is the same. Even if you are odds on to win, the downside risk is not worth it if you are gambling with money you really can't afford to lose.

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At 07:53 on March 27 2008, WhyEye said:

I would unhesitatingly echo Tonjt's comments. I too was recently made redundant after 11 years with the same company, and at the time had two mortgages, one of them very large on a house we were in the process of building. The pleasure at now having no mortgages to repay is beyond words. As for the stock marklet, someone once told me you should never invest what you can't afford to lose. I don't..

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At 08:03 on March 27 2008, MalcolmShennan said:

Investing also requires trust, an element of public goodwill, eroded by the modern Bish Bosh unaccountable culture amongst blue chip executives borne in a computerised environment.

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At 08:04 on March 27 2008, SWEDISH100 said:

When the Stock market was near its peak last year I decided to sell some of my and the wifes investments to pay off the mortgage.
The shares I sold would be worth 40% less now if I had held on to them so I believe it is all about timing and am very pleased with my decision.
I now invest what I was paying each month for my mortgage into a range of unit trusts within an ISA.

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At 08:41 on March 27 2008, AdAstra100 said:

I have paid off my mortgage but haven't actually paid it off. Similar but not exactly the same as having spare cash. I have an offset mortgage and Foolishly I keep my mortgage repayment funds (£75K) in the offset savings account. I pay interest at a typically higher 'offset' rate BUT my offset means that the payment is actually used to pay off capital, ie reduces the £75K,because the lump sum plus my current account balance reduces the mortage interest debt to zero. So, next month my interest debt is lower but I still pay off the same repayment (from the earmarked funds) and my capital debt reduces further. Thus I do not add any new money to sustain the mortgage. What is the benefit? Well it gives me instant access to a cash lump sum which I can use to draw down my own personal loan (for up to £75K) without any overhead cost while it is balanced and only a marginal cost if I use the loan facility Foolishly. I can then save cash back into the offset savings account to restore the status quo with no effect on my outgoings and in my own time. The other significant benefit is that if I die the cash is available for my executors to use and not tied up in house equity. It needs self discipline of course but then I assume most people who visit this site would have that discipline.
Regards

AdAstra

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At 09:36 on March 27 2008, dasv said:

UK interest rates are likely to fall but libor is still high pushing up APRs on most mortgages. It is unknown whether the return in the next year from equities will be higher than the total borrowing cost for a mortgage.

However if you have the cash to pay off your mortgage, and instead diverted monthly mortgage payments to your SIPP or stakeholder pension, there is no better guaranteed return than this once tax relief has been taken into account. 40% tax payers clean up with this deal - imagine instead of paying £1k into your mortgage, paying £1k cash into you pension per month - the tax relief would be £666 so you'd actually be saving £1666 gross into the pension (unless I've got my sums wrong).

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At 10:00 on March 27 2008, JasKing1 said:

I do a combination of both making overpayments and using my ISA allowance for cash and stock market investments. The reason that I don't solely make overpayments is that if I manage to pay off my mortgage completely, I would have a huge surplus of cash each year. All those ISA allowances would be gone and I would not be able invest the money efficiently. My mortgage allows 10% overpayments without penalty, so I get a competitive interest rate (offset is usually ~0.5% higher) on my entire mortgage balance. I am not able to pay >10% per year in overpayments.
Furthermore, current cash ISA best-buy interest rates are significantly higher than my mortgage interest rate. It makes no sense to make overpayments before I have used my cash ISA allowance currently.
Therefore for me (I a still in my early 30's), the above approach works best as I have plenty of time to let my stock based investments grow.

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At 10:38 on March 27 2008, QuarterP said:

In a similar vein to JasKing1 I also have not paid off my mortgage even though able to do so. I am in my 50s with only £9k left to pay but the fee for paying off early plus the fee for the bank to keep the deeds just about balances the interest I receive on savings. Since I have no other debts but may want to borrow more in future it makes sense to keep the mortgage open otherwise a) my credit rating will drop and b) I'll have to pay more fees to open a brand new mortgage if I need a new roof etc.
There's more to consider than the mortgage interest.

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At 10:59 on March 27 2008, HeAintHeavy said:

Dear Neil, With shares conastantly out-performing investment (your figures of 10-11%) and with a mortgage being a very longterm investment on the most part, your conclusion seems foolish (small f) unless you are pointing at people with little time left to pay. I thought you would at least have divided the funds to cover your "safe bet" leanings. How safe is your bet with inflation creeping up? We Fools needing to maximise our funds.

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At 11:18 on March 27 2008, hazybrain said:

A healthy mix of both rather than throwing everything at the mortgage is the way to go for me.

An example, with daft (but easy to work out) numbers and ignoring all the finer details:

You have a 'saveable' income of 1060 a month and a 100k mortgage at 5%.

If you pay 660 a month then it's paid in 20 years with 58k of interest. You then put the 400 extra a month into a 5% savings account. This gives you 166k. So after 20 years you have a house and 166k in the bank.

If you pay 1060 a month then it's paid in 10 years with 27k of interest. You can then invest 1060 a month in savings for 10 years. This (strangely enough) gives you 166k after 10 more years.

So after 20 years you have a house and 166k. Regardless of which route you took, or how much interest you actually paid on the mortgage. The only differences are how easily you can get a 'as good or better' savings rate and how much you value liquid assets. Personally, regular smaller savings and minimal mortgage payments make most sense for me - more likely to not get stung by tax (hello ISAs!) and always have a pool of cash available if it was required.

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At 11:34 on March 27 2008, chasm007 said:

Thanks for all the advice because I'm in the same situation in an off set mortgage although I have a combination of savings and about 16k on zero % Credit cards which is reducing the interest per month by about £100. The best advice on here was not to get rid of the mortgage all together as I see we can avoid arrangement fee's.

I was wondering what would be best to do when the savings are greater than the mortgage and either an ISA or extra pension fund would work. Although I have a company pension which is already added to.

for me this was the best article so far and thanks for the info.

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At 11:44 on March 27 2008, ManSensible said:

An offset works for me, and might work for QuarterP too. We have exactly the same amount of savings in the offset account as outstanding mortgage, so we earn nothing on savings but pay no interest either. That way, we have no monthly outgoings, but retain access to the whole value of the mortgage/savings if we need it one rainy day. We haven't been hit with any charges for doing this, and obviously no penalties for paying off the mortgage early. This is also potentially significant as I'm told it could be difficult to get decent terms on another mortgage in the future if, heaven forbid, we should ever need one and we have been seen to have paid one off early in the past.

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At 13:05 on March 27 2008, ascentium said:

Well, I also have an offset mortgage, and it works for me.

On the "average stock market returns" thing, surely we should be looking at actual performance, after charges, from index tracker funds.

The problem with looking at, say, the FTSE-100, is that as companies drop out, and new companies join, there are extra transaction costs AND the index has a survivorship bias.

On that basis, paying off the mortgage by the time I'm 40 is looking like a good thing :-)

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At 14:23 on March 27 2008, collthetroll said:

This is why companies borrow money because they can make more money than what it costs them. Its only when they borrow too much and earnings don't cover interest payments things can get tricky.

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At 14:25 on March 27 2008, TMFVertigo said:

Thanks for your responses, folks! I expected more support for shares. Interesting...
A couple of you asked me why I didn't argue for splitting the spare cash between investing and repaying early. It's because I made the assumption (right at the start of the article) that you were already investing enough for a comfortable retirement. Hence my call not to risk any further money on shares, and to plumb for a guaranteed return (i.e no more mortgage repayments/rent) with the difference. As I said though, it's an entirely personal decision. There's no right or wrong, provided you understand the risks/rewards...
HeAintHeavy, you asked how safe my bet was (and intimated it wasn't safe by putting the word Safe in speech marks!) with rising inflation. You can't really get much safer than having no mortgage or rent to pay, especially if you are, as I said, already on course with your retirement investments, too. I also think that assuming 10% to 11% returns is a bit risky, hence why I qualified that later in the article...
Thanks once again for all your comments and questions. I really think it helps other readers to make better decisions...
Neil (the author)

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At 16:08 on March 27 2008, 416sli said:

Like it or not, large scale redundancy is now seen as a viable method of corporate cost control. As a result, people are increasingly told to accept redundancy as a natural part of their working life.

I was made redundant some years back, and the thought of no money coming in, together with the monthly mortgage demands was not a comfortable feeling; even with some of the payment being met by an insurance policy.

I vowed that when I had got another job, I would overpay for 2 years and then use a lump sum from my savings to kill the rest.

I have no regrets. Should I be made redundant again, then at least it is one less thing to worry about.

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At 16:21 on March 27 2008, FAZERSIX said:

Stock Market V Paying you mortgage off mmmm
My opinion is security of funds,so the stock market mmmm.
I think its best to hold onto your cash in a high interest easy access account earning compound interest, if you get into finantial bother your funds are instantly available.
You could then pay your mortgage at any stage assuming you kept sufficient on deposit

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At 17:54 on March 27 2008, chaz25 said:

Seems very simple to me. PAY OFF the mortgage.
House should rise in equity/ real value. If you need money, this equity is available, especially if the credit crunch continues! Mortgage interest rates (previously unmentioned!) are a TOTAL gamble. If the financial markets collapse, I'll be laughing all the way to the bank! Not so with a large mortgage left to pay. Pay off the mortgage and sleep comfortably/ soundly at night!!!!

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At 19:58 on March 27 2008, izzykitten said:

We both save into ISAs but also pay a few hundred pounds extra off our mortgage each month. That's the best of both worlds for us - we also want to be "comfortable" and this way we don't really risk anything.

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At 22:07 on March 27 2008, castath said:

I was glad when I saw that it was Neil who was the author to this article although I was a little disappointed that he couldn't
offer an argument other than it was down to your attitude to risk.

I have taken comfort that may Fools consider asset liquidity a very important issue, especially since we are in the middle of a credit crunch. I too used to have an offset mortgage that was backed by just as much in savings, unfortunately we needed more space and I had to take on an additional 1.5 times existing mortgage when I moved house, so I swapped the offset and hedged a 10 year fixed rate.

I would recommend using your cash ISA allowance first. You have to be Foolish and track the best rates. The reason why I say it is suppose you manage by overpaying your 25 year mortgage each month to reduce your mortgage term and pay it off after 20 years. Now I know you should never expect these things and you can't time them, but there is a good possibility you could inherit some money at some stage, suppose you inherit £100k, if you put this in a savings account at 5% and you are a basic rate tax payer,
you would earn £5k in interest but £1k of it would be paid in tax each year. If you correctly manage your savings and use ISA allowances instead of paying off the mortgage you give yourself the option to use the ISA to pay off the mortgage when you want, you can access the cash in emergencies and if you get an inheritance you can use this money to pay off your mortgage first and leave your ISAs intact.

I know the article was comparing Investing v Paying of the Mortgage, I am just highlighting an additional hedge.

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At 10:53 on March 28 2008, TMFVertigo said:

hi castath.
"I was glad when I saw that it was Neil who was the author to this article..." Thanks, that's nice! I think us writers don't believe we exist unless we're getting positive feedback :-)
Regarding the point of your comment - liquidity. I didn't mention that because I made the assumption that anyone in this position would also have plenty of money in savings. Sorry I didn't specify that at the beginning. We write so often at The Fool that you should have a decent savings pot before you invest anything at all that I forgot. You should certainly have a decent pot of cash at all times, once you've paid off your card debts.

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At 20:09 on March 28 2008, wurzel1945 said:

I've mortgaged my property & paid it off about 4 times now, the advantage is that as your property goes up, you can hock it for more than before & buy another property to let out,which will add to your well being & peace of mind, sort of like playing monopoly in real life. Try it!

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At 21:42 on March 28 2008, satriani100 said:

Like a few others that have made comments, I was also made redundant but it was voluntary. I was also over 50 by 5 days so was able to take my pension. I already had an off-set morgage. Prior to leaving the company, we (there were a few of us) were offered the services of Independent Financial Consultants. I asked their view with regard to paying the morgage off or simply matching what I owed in a savings account with the same company. The answer was put the money in the savings account as the morgage is then totaly interest free. If I paid it off, the money is gone. If I put it in a savings account then it's always there if I got desparate. That's what I did so I now have an interest free morgage. Every penny I pay comes of the capital owed. Any excess in the savings account earn interest. I was also fortunate to get another job as good as the one I left plus the pension comes in every month.

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At 15:44 on March 30 2008, foolcouk100 said:

If you pay tax at the higher rate of 40% then any investment paying 6% interest is really only worth 3.6% after tax. If the same money is put into a mortgage charging 6% the true interest rate you would be earning from this is 10%. I can't see how there can be any comparison. Unless the stock market can pay more than 16.7% how can there be any logic in investing in the stock market over paying off your mortgage? As far as I can see only maybe investing in your pension can match this. Have I got this wrong?

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At 17:07 on March 30 2008, tedphill said:

As it shows, everyone has different reasons. Mine is not to pay of my mortgage at 4.8%, it used to be 3.8% I pay AVC's giving me 22%, plus 4.5% interest. over 5 years = 9% tax free. Over 10 years it's still 6.5% tax free. Yes I also use my cash ISA and our lump sums are in my wife's name paying monthly income tax free.

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At 16:57 on April 24 2008, krishcanag said:

Its all wrong!!
If you have a mortgage with a 6.74% interest and a ISA with a 5.1% rate you would think reading the article it would be better to put it in the mortgage, WRONG, WRONG.

I did my calculations on 62000 mortgage and 17000 in ISA over 13 years. If I reduce my mortgage to 45000 taking out my ISA I save interest charges of 8500 (this is because of the way repayment parabolic graph works) while if I keep it in an ISA it earns 15000, so overall I am better off keeping it in an ISA

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At 13:49 on May 07 2008, MrP0P said:

Hi Krishcanag,
Not sure how your numbers work.
to pay off a mortgage of £62000 in 13 years @ 6.74% will make the repayments £600.
And as you state that 17000 will be worth around £32,943.98 @ 5.1% in 13 years.
However if you reduced the mortgage to £45000 then at the same repayment rate (£600) you could repay the mortgage in just over at years (8yrs 2mnts)
This means in the final 4 years and 10 mnts (leading up to the same 13 year period) you would have 58 mnts of £600 to invest.
If you did nothing with it at all then you'd still be ~£1,856 (58*£600-£32,943.98) better off but if you put £300 into a the same ISA(@5.1%) and the other £300 into a high saver account (@4.8 after tax) each mnt then you could have a lump sum of upto £39,405 at the end of 13 years which would make you £6,461.02 better off. (I think...)

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