3 reasons to not overpay a mortgage

Paul Summers reveals why he’s chosen to stop tackling his biggest debt.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

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. 

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Hand of a mature man opening a safety deposit box.
Investing Articles

If I’d invested £5k in red hot BAE Systems shares 5 years ago here’s what I’d have today

BAE Systems shares have smashed the FTSE 100 for years and Harvey Jones is keen to buy more as they…

Read more »

Investing Articles

How I’d aim to earn £16,100 in passive income a year by investing £20k in a Stocks and Shares ISA

Harvey Jones is building a portfolio of high-yielding FTSE 100 dividend stocks that should give him a high and rising…

Read more »

Investing Articles

Down 8% in a month! The BP share price is screaming ‘buy, buy, buy’ at me right now 

When crude oil falls, the BP share price invariably follows. Harvey Jones is wondering whether this is the right point…

Read more »

Bus waiting in front of the London Stock Exchange on a sunny day.
Investing Articles

Could the 9.8% M&G dividend yield get even bigger?

Christopher Ruane reckons that, although the M&G dividend yield is already close to a double-digit percentage, it could get better…

Read more »

Investing Articles

How much passive income could I earn by putting £380 a month into a Stocks and Shares ISA?

Christopher Ruane explains how he'd aim to turn a Stocks and Shares ISA into four-figure passive income streams each year.

Read more »

Investor looking at stock graph on a tablet with their finger hovering over the Buy button
Investing Articles

2 passive income stocks I’m buying before an interest rate cut

With the market expecting interest rates to fall in August, time might be running out for investors looking to buy…

Read more »

Investing Articles

If I’d bought Rolls-Royce shares a year ago, here’s what I’d have now

Rolls-Royce shares have been the big FTSE 100 success story of the past 12 months and more. And there's still…

Read more »

Young female analyst working at her desk in the office
Investing Articles

If the Dow’s heading for 60,000 by 2030, can the FTSE 100 index hit 12,000?

Strategist Ed Yardeni predicts a 50% rise for America’s Dow Jones Industrial Average over six years. Can the FTSE 100…

Read more »