Should I Pay Off My Mortgage or Invest (3 ways to decide on the right route for you)

Phil Hendry20/04/2021

This is a really great question and there will be a right answer for you, it just won’t be the same as everyone else!

We have an interesting view towards debt in the UK, quite rightly, which tends to be that we should be rid of our mortgages as soon as possible…at the very least by the time we retire. Did you know the German word for ‘debt’, is the same as ‘guilt’? When it comes to mortgages, I think this framing resonates in the UK. Because of that, often the first thought is to pay down our mortgage if we have built up savings, but is this the right one? For some people, definitely.

A number of facets play into making a decision on the right route for you though.  Here are the things I think you should research/consider:

Do you have other debt?

In some cases, you may have other types of debt, such as student loans or credit cards, which typically are very expensive to carry. Interest rates are often 15-20% per annum on credit cards, which is significantly higher than the interest rate you will pay on your mortgage, particularly if it’s the mortgage on your main residence. This rate can be as low as 1-1.5% depending on the size of your loan compared to your house value.

So think about any other debt that would make more sense to clear before your mortgage.

What rate of interest are you paying?

Do you know what this rate is? If not, keep on top of it! As mentioned above, this can be incredibly low, as interest rates have moved down steadily over the last 40 years. Back in the 80’s and 90’s interest rates were commonly in the teens. In 1979 Margaret Thatcher’s government raised them to 17% to combat price increases (inflation) in the UK…no wonder everyone had interest-only mortgages at the time!

If your interest rate is incredibly low, you are not tormented by the thought of debt and your mortgage payments are very affordable, investing instead of paying down debt may be a good alternative. Obviously investing can come in many forms, ranging in risk and in types of thing to invest in. But let’s take a classic Balanced Portfolio invested in the stock markets. This is a good example of an investment that is middle of the road in terms of risk and a good one to use. Since 1929, on average a portfolio where 60% is invested in global company shares, and 40% is invested in lower-risk things like government bonds, average annual returns were 8.77%*. If you are paying interest at 1.5% say, but a medium risk investment pays 8.77% per annum, why would you pay down your mortgage instead of investing?

Well, massive caveats are that it is generally accepted returns over the medium term (5-10 years) are unlikely to reach historic averages, so don’t assume 8.77% per annum in calculations! I would say though that returns are still likely to exceed 1.5% in a medium risk investment.

Also, interest rates could begin to move up. Again, this seems unlikely in the medium term given the level of borrowing both governments and households have, however a return of inflation may force interest rates up sooner than we expect. This would mean you are paying more on your mortgage, and therefore the additional risk of investing, may not make any sense and paying down your mortgage would be a no brainer.

What are you keeping your money liquid for?

When I say liquid, I mean able to turn an asset into cash quickly if needed, you could put stocks and shares in that category. Are there things you would want to keep money in this format for? School fees? Saving for a holiday home? Saving for a worldwide trip for a big birthday?

As anyone would testify to, applying for a mortgage is not a quick and easy process. Nor is selling a property, if this is a route you were to go down to fund something for the future.

However, you may not have plans like these, or you could meet the cost with income from your job or business. In which case, needing to keep money in a liquid format is really not a concern, so paying down your mortgage would make more sense.

If however you do aspire to these things and will need savings to fund it, paying down more of your mortgage may make it difficult to extract your savings back out to fund your aspirations.

As I started by eluding to, you are all going to be different, in terms of comfort with risk and life events you need to plan for. But hopefully, these points get your thought process going in the right direction to land on the right decision for you. There are no certainties, but the more you plan ahead for things in life, the more confident you can be in whatever decision you make.

 

*Historical Index Risk Return (vanguard.com)