A mortgage is the biggest financial commitment many of us will ever take on. As such, it can make a lot of sense to pay off this debt as quickly as possible. Indeed, that’s why I’ve been trying to make overpayments to my own loan over the last few years.
Last month, however, I decided to stop doing so for three reasons.
Low rates
First, a bit of context. In the last month, I switched to another fixed deal at a lower rate that I was previously paying. Much my father’s indignation (he grappled with double-digit percentages back in the 1990s), my new rate is a little under 2%.
The fact that I’m now paying less than half the rate of interest I was before means there’s a bit of cash leftover. “So why not carry on making overpayments“, you might be wondering?
One reason relates to the product itself. Unsurprisingly, there are limits to how much a lender will let you pay off within a certain time frame. Go over this limit and you’ll be penalised. With repayments now less than they would have been had I not tackled the mortgage head-on in the past, this was a potential issue for me. It may be a risk for you too.
A second reason relates to the benefits that come from moving this extra cash into my Self-Invested Personal Pension (SIPP).
As I’ve mentioned before, SIPPs are a very attractive option for most long-term investors. In addition to letting you shield any investment profits from the taxman, having a SIPP means you’ll also receive tax relief from the government on any money you pay in.
In practice, this means that someone with, say, £100 left in surplus cash every month will get an additional 25% on that amount if they put it in their SIPP, assuming they pay the basic rate tax. So, they’d have £125 rather than £100 to put to work.
My third reason follows on from the second. Right now, the yield generated by a simple exchange-traded fund that tracks the FTSE 100 is higher than the interest being charged on my mortgage debt (although, clearly, rates might rise in the future). As such, I stand a chance of generating more wealth over the long term by investing the spare cash, reinvesting the income I receive in my SIPP and allowing compounding to work its magic.
A word of caution
Whether someone should switch from overpaying their mortgage to putting any surplus cash to work in the market will clearly depend on their circumstances. The latter option is far riskier.
Shares might plunge tomorrow and, in doing so, reduce the value of any money not used for the mortgage. Contrast this with the comfort felt from knowing you’re tackling your biggest debt faster than originally intended, thus potentially saving you thousands of pounds in the process.
There are ways of mitigating this risk. Buying liquid, diversified funds (such as that mentioned) rather than individual company stocks should temper some of the volatility. A commitment to investing for decades rather than a few months or years should also make it easier to deal with things on an emotional level.
Ultimately, both overpaying and investing are good ideas but the best option for someone will always be that which allows them to sleep at night.
