Being mortgage-free is a key indicator of financial security for many people in the UK, especially as house prices and borrowing costs have increased significantly in recent years.
According to MoneyWeek, paying off their mortgage is the number one financial priority for millennials aged 28 to 43. Gen Xers, aged 44 to 59, place being mortgage-free number two on their list of financial goals after securing their retirement.
You might feel the same, and if you have surplus funds to spend, you may consider overpaying your mortgage. While this could help you clear the debt faster and reduce the total amount of interest you pay, there are alternative ways to spend excess cash.
In some cases, it may be more beneficial to invest the funds instead.
The most suitable option depends on your unique situation, financial goals, and attitudes toward debt and risk.
Read on to learn more.
You could significantly reduce the interest you pay and clear your mortgage faster by overpaying
One of the key benefits of overpaying your mortgage is that you will pay less interest overall, potentially saving you a significant sum. You’ll also reduce the term of the mortgage, meaning you pay off the debt faster.
Figures from MoneySavingExpert show how much you could save by overpaying a £150,000 mortgage with a 25-year term and an interest rate of 4.5%.
The findings showed that overpaying:
- £50 a month could save £11,180 in interest and reduce the term by two years and six months
- £200 a month could save £33,130 in interest and reduce the term by seven years and seven months
- £500 a month could save £54,890 in interest and reduce the term by 12 years and 10 months.
As you can see, overpaying your mortgage could mean that you become mortgage-free much more quickly. Consequently, you free up those funds each month to spend elsewhere, potentially giving you more financial freedom.
There is also a strong emotional benefit of being mortgage-free, as for many people, owning a home outright represents financial security.
Reducing your debt could help you find a better deal when remortgaging
Clearing your mortgage altogether isn’t the only reason to overpay, as you could also benefit when remortgaging.
The interest rate on your mortgage is affected by several factors, including your loan-to-value (LTV) ratio. Your LTV ratio is the difference between the amount you borrow and the purchase price of the property, expressed as a percentage.
For instance, if you purchase a £300,000 house with a £50,000 deposit, you will borrow £250,000.
Your LTV ratio is around 83% – you are borrowing 83% of the value of the home.
As you pay off more of your mortgage, the percentage of the property you own increases, while the amount you owe falls and your LTV ratio changes.
Using the example above, if you paid off £50,000 of your mortgage on top of the initial £50,000 deposit, you would now own £100,000 of the property’s value.
If you remortgaged, and the property was still worth £300,000, you would need to borrow £200,000.
This means you have an LTV ratio of roughly 67%.
As a result, you may be able to secure a more favourable interest rate, potentially reducing your monthly mortgage payments. This could free up additional funds to improve your quality of life and to save or invest for the future.
By overpaying, you bring your LTV ratio down faster and could reduce your mortgage payments further. This may be especially beneficial if interest rates rise again in the future, as you have some protection from increasing mortgage payments.
Investment returns could outweigh the saving you make from overpaying your mortgage
Overpaying your mortgage could save you a sizeable amount of interest over time. However, if you were to invest the additional wealth instead, the potential returns could outweigh the money you’d save by overpaying your mortgage.
The following example from Vanguard demonstrates how this could work. The figures show how much interest you could save by making a £15,000 overpayment on a £250,000 mortgage, with a fixed interest rate of 4.59%, at the start of a 10-year term.
The total saving would be £6,030.
In comparison, if you invested the £15,000 in a Stocks and Shares ISA and left it for 10 years, the data suggests you could see returns between £11,060 and £11,980, depending on the makeup of your portfolio.
Naturally, these figures are illustrative, and past performance doesn’t guarantee future returns. Also, investing means you adopt a level of risk that you wouldn’t face when overpaying your mortgage.
However, the data demonstrates that long-term investment returns could be much greater than the saving from overpaying your mortgage.
It’s also worth noting that the lower the interest rate on your mortgage, the larger this disparity could be because the saving from overpaying will be smaller.
Additionally, there may be a limit on how much you can overpay each year without incurring early repayment charges.
You may want to keep these factors in mind when deciding whether to overpay your mortgage or invest the wealth instead.
It may be more difficult to access wealth in your home
As well as the potential gains, it’s important to consider how and when you plan to access your wealth.
Overpaying your mortgage means you build equity in your home faster. But if you want to access that wealth, you’ll need to sell the property or remortgage.
Meanwhile, if you invest instead, it may be easier to sell investments and unlock the wealth should you need it to achieve certain financial goals. That said, it’s important to seek professional advice before selling investments to ensure you consider the effects on your portfolio and wider financial plan.
Get in touch
We can discuss your unique goals and determine whether overpaying your mortgage or investing is more suitable for you.
Please give us a call on 01276 855717 or email info@braywealth.com today.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
Past performance is not a guide to future performance and should not be relied upon.
The value of investments and any income from them can fall as well as rise and you may not get back the original amount invested.
| YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE. |
Think carefully before securing other debts against your home.
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