The FTSE 100’s recent decline may convince some individuals that repaying their mortgage is a better idea than investing in shares. Certainly, doing so poses less risk of loss. A lower outstanding mortgage means you’ll pay less interest each month, and could be debt-free sooner than otherwise would be the case.
However, with interest rates low and the FTSE 100 offering long-term recovery potential, it may be logical to invest rather than overpay on your mortgage. Doing so could boost your long-term financial prospects.
At the present time, UK interest rates are close to their historic lows. As such, most mortgagees are likely to be paying a relatively modest interest rate on their debt. This means that overpaying your mortgage is unlikely to make a significant difference to how much interest you end up paying.
For example, if you have a mortgage which has an interest rate of 3%, overpaying £1,000 would only reduce your annual interest payments by £30. By contrast, investing that money in the stock market could enable you to enjoy a high rate of return in the long run, which improves your financial prospects.
In fact, with the FTSE 100 having recorded an annualised return of over 8% since its inception in 1984, your £1,000 could produce a return of £80 per year. Furthermore, with compounding having the potential to catalyse your returns over the long run, a £1,000 initial investment, which generates an annual return of 8%, could be worth as much as £4,660 over a 20-year time period.
Of course, there’s no guarantee that the FTSE 100 will record an annual return of 8% over the long run. Its recent performance highlights the risks involved in buying shares.
However, over the coming years, the index is likely to revert to its average return. Its track record shows that it has always recovered from its various bear markets and corrections to post new record highs. Therefore, if you’re able to commit to investing over the long run, buying shares could certainly be a better idea than overpaying your mortgage – especially since interest rates look set to remain at low levels for some time.
Starting to invest from scratch could be an easier process than many people realise. Opening a Stocks and Shares ISA is a cheap and straightforward process that can be undertaken online in a matter of minutes, in many cases. Furthermore, buying a FTSE 100 index tracker fund provides diversity at minimal cost for new investors, or for those individuals with limited capital.
Although overpaying your mortgage can save you money on interest payments in the long run, the return prospects of the stock market — and low interest rates — mean investing your capital could have a more positive impact on your long-term financial situation.
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Peter Stephens 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.