If you have saving available, is it better to overpay your mortgage, or use the money to invest?
There isn’t one right answer to this question. As always with personal finance it depends on your individual circumstances and future goals.
If any of these are not yet in place, it’s not even a contest!
How do mortgage overpayments and investments compare? ⚖️
Mortgage overpayments provide a guaranteed return of the interest rate on your loan.
In theory, if you could find a savings account with the exact same interest rate as your mortgage, putting your monthly savings into one or the other would give identical results. If you could find a savings account with a higher interest rate than your mortgage, you might be better off saving there than overpaying your mortgage.
In practice, neither such savings accounts are available. To beat your mortgage’s rate, the only option is to invest in assets which carry some risk.
Investment returns are not guaranteed or known in advance. Historically, when held over a long term, they have returned an average of approximately 4-7% per year depending on the amount of risk taken.
Since mortgage borrowing also tends to be long term, comparing the two is not unreasonable, but it’s still apples and oranges – a certainty vs a probability.
Many people would pick an investment which was guaranteed to return 4% over one which has a track record of returning an average of 3-7%.
This is why in the flowchart, we recommend that any debt at 4% interest or above should be prioritised above saving and investing. It is only at low interest rates that investing starts to become more attractive than debt repayment.
Mortgage overpayments are tax-free 💰
This one might sound odd, but you don’t pay tax on interest you haven’t paid. Whereas interest you receive from a savings or investment account may be subject to tax.
This means that £100 of interest saved on a mortgage should be compared to £100 in a tax-free savings/investment account such as an ISA, rather than a taxable account.
In practice, it is slightly more complicated. The personal savings allowance means most people won’t pay tax on savings interest up to £1,000 per year or dividends of up to £2,000 per year, and investment growth is taxed as capital gains which has its own rates and allowances.
Mortgage overpayments are illiquid 🧱
When you make a mortgage overpayment, you lose access to the money. To get it back into your bank account and spend it you have to re-mortgage your property, which costs money and takes a minimum of a few weeks to arrange. You can’t sell a brick or two of your property to make ends meet!
In contrast cash savings and investments are very liquid. Having your money more readily available could be an important benefit of choosing to save outside your mortgage.
On the other hand, it could be a disadvantage, if you end up reaching into your savings frequently or for unimportant things. That temptation isn’t an issue if you have overpaid your mortgage.
Mortgage overpayments carry a psychological benefit 🧠
Many people who have fully paid off their mortgage say it’s one of the most exciting and satisfying financial milestones they have achieved. Removing your largest monthly bill can feel liberating.
This needs to be given proper consideration against a potentially more “optimal” solution.
Comparing using projections 📈
The table below illustrates a 30 year, £200,000 mortgage with a 2% interest rate. This comes to payments of £744 per month, and this person has an additional £250 per month available for long term savings which they are considering:
- Keeping in the bank
- Using to overpay the mortgage
As you can see:
- Overpaying the mortgage saves tens of thousands of pounds and ends the mortgage years earlier
- Assuming a mortgage rate of 2% and a predicted investment return of 7%, it’s more profitable to use those additional funds to invest rather than overpay
Making your own projection 🧮
To make an informed decision, construct your own table for the scenarios you’re considering, using your real mortgage and saving details.
If you’d like to edit the table displayed above you can copy it from here.
There are also online calculators available to help:
- https://www.moneysavingexpert.com/mortgages/offset-mortgage-calculator/ (enter your expected investment return as savings interest)
Remember, you don’t necessarily have to pick one or the other. You may decide that going all-in on finishing the mortgage early or building an investment portfolio is right for you, but you could also do a bit of both if you prefer.
Should I overpay to improve my Loan to Value (LTV) and interest rate? 💸
The simplified table above assumed a consistent interest rate of 2% throughout the life of the loan. However in reality lenders offer better rates the smaller your loan is in comparison to the value of the property.
If by overpaying £10,000 your interest rate drops from 2% to 1.5% on a £200k loan, that’s an interest saving of £1,000 per year, which is roughly equivalent to a 10% PA return, in addition to the interest saved on the repayment amount itself!
The trigger points for LTV change over time, but in 2021 these tend to be 90%/80%/75%/60%. If your mortgage is close to renewal, and the lending is close to a trigger point, you should consider the benefits of this course of action.
Should I overpay now in case of higher interest rates in the future? 🔮
Fear of future interest-rate increases is not a great reason to overpay a mortgage. If you chose to invest the money instead, and a future interest-rate rise were to happen, you could simply overpay at that point.
In general it doesn’t make good financial sense to make decisions today based on possible future changes.
What if I have received a lump sum? 🧧
If you have received a lump-sum, the decision-making process is the same as with regular overpayments.
You may also be interested in reading our windfall page.
Never pay fees to overpay ❌
Many mortgage deals charge an ‘Early Repayment Charge’ if you overpay more than a certain permitted amount.
Note that this only applies during your fixed rate period. If you’re overpaying high enough amounts that you will incur an ERC, it is almost always worth it to wait until your fixed period is over and pay the money in while it’s free to do so.