Discover the pros and cons of paying off a mortgage early vs investing. Make an informed decision with our guide.
Can you save more money paying your mortgage off early than you could earn from investing in a low cost global index fund? What other factors should you take into account? Let’s take a closer look...
Paying off mortgages vs investing in the last decade
Over the last decade, investing in the stock market has been more profitable than paying off the mortgage early. Persistently low-interest rates have made large mortgages feel relatively cheap and house prices have gone up constantly thanks to the low cost of borrowing.
This has seen people get property rich and at the same time, returns from investing in the stock market have been higher than mortgage interest rates: a win, win situation!
So, using money to invest in low cost global equity funds rather than using it to pay off a mortgage early has been very profitable in the last decade as shown by the following 2 examples.
January 2013: Lump sum example
Let's say you are planning to remortgage for 10 years with £100,000 outstanding, but you have £100,000 invested in the Vanguard Lifestrategy 100 fund.
In January 2013, a 5 year fixed rate mortgage was around 4%, a monthly cost of £1,012.
(4% was high compared to the rest of the noughties and the remortgage for the second 5 years may have been at a better rate).
Should you pay off the mortgage in full or stay invested?
Stay invested: From January 2013 to January 2023, £100k invested in the Vanguard Lifestrategy 100 fund would have grown to approx. £261k.
Pay off the mortgage: Investing the monthly mortgage payment of £1,012 for 10 years in the Vanguard Lifestrategy 100 fund would return approx. £209k.
The fact that the Vanguard fund has returned approx. 10% on average per year (162% over 10 years) as compared to the mortgage costing 4% means that by staying invested you would have been better off by £52K.
January 2013: Monthly overpaying example
Let’s say we decided to take the mortgage from above and overpay every month by £160.
This would reduce the mortgage period to 8 years and 5 months, saving interest payments of £3,600.
Alternatively, investing £160 a month over the same period of 8 years and 5 months in the Vanguard Lifestrategy 100 fund would return £9,000: £5,400 better off.
If the £160 a month is invested inside a Pension or LISA, this would increase the monthly amount deposited to £200 which would return £11,300: £7,700 better off from investing rather than paying off the mortgage early.
Paying off mortgages vs investing in the next decade
Of course, the elephant in the room here is that the two rates are not guaranteed for the next 10 years. The 5 year mortgage rate today is currently around 5%, but forecast to fall over the coming decade (I will get my crystal ball out!). Returns from the stock market are equally unpredictable; over the last 12 months, the Vanguard Lifestrategy 100 fund has returned 1.5% (remember, investing is for the long term).
Paying off your mortgage is a guaranteed return, unlike the variable and unknown returns from the stock market. The fact that you could lock into a specific mortgage interest rate for 2/3/5/10 years gives some certainty. Returns from investing are uncertain and volatile. There is only one reason to invest instead of paying down your mortgage - you hope investing will leave you richer.
This is a financial decision, but you also have to consider the psychological cost of your decision. Debt is a burden and many people feel a great sense of relief when their mortgage is paid off. For many, the potential to earn more from investing is of less concern.
Imagine the psychological cost if you had the opportunity to pay off your mortgage, but instead invested the money and subsequently lost 25%. How would that make you feel? If this would bother you, it should be factored into your decision. You might regret investing if you are unlucky.
Your mortgage rate never fluctuates so it is similar to a ‘guaranteed return’, whereas the returns on a stock portfolio will vary widely from year to year. For those who can invest for a long period and ignore the variation, the math might work. However, the reality is many people panic-sell during bear markets and panic-buy during bull markets, achieving returns far lower than the market average.
Best of Both Worlds
It doesn’t have to be one or the other. In the real world, you might be a cautious individual and prefer the security of paying off the mortgage – a guaranteed return. Your partner may be more adventurous and like the idea of possibly making a better return from investing. Sit down together and decide on a happy medium, say 50/50.
In the example used earlier, this would mean overpaying the mortgage by £80 a month and then investing £80 a month (made up to £100 in a LISA or pension). Guaranteed return and potential gains. Lowering debt and investing in the future!
You could further reduce your risk by investing in a balance of stocks and bonds; or even in cash. Both historically have returned less than 100% in equity but with less volatility, and by saving/investing within the LISA and pension wrapper you would get the automatic 25% tax back boosted return.
(Cash in savings accounts outside a LISA or pension is unlikely to return more than paying off the mortgage).
Remember: house prices are volatile, but it is irrelevant if house prices fluctuate when it comes to the returns you see from paying off the mortgage or investing; you have already locked-in the purchase price of your home. Paying off the mortgage delivers a known return, investing earns an uncertain one, and house prices fluctuate regardless.
Before you consider paying your mortgage off early or investing:
• You should first have an emergency fund and pay off any bad debt (Mortgages are good debt). The interest rates on credit cards and loans are much higher than on a mortgage; credit cards typically charge 20% or more, double the average returns you dream of achieving in the stock market.
• You should know your monthly budget and know your cash flow needs. If you use all your liquid cash to pay off your mortgage, you are potentially left with inaccessible capital that you might need in a pinch, for example, if you lose your job or the central heating boiler breaks down. Of course, by paying down your mortgage, your monthly cash outflows are reduced, but you still have bills to pay.
• You should consider whether you are maximising the tax-free cash opportunities provided by a LISA and a Pension taking into account the drawbacks; money can be taken out of the LISA for emergencies but there is a penalty to pay; money can only be taken out of the pension from age 55 (rising to 57 from 2028).
• You should take note of the T&C’s of your mortgage and avoid any early repayment charges. Most lenders only allow proportional lump sum mortgage overpayments – for example, 10%.
• If you do decide to overpay the mortgage, make sure the mortgage provider reduces the term of your repayment rather than the monthly amount you pay as this would negate the benefit of making the lump sum payment.