Should I Pay Off My Mortgage or Invest?

Phil Hendry20/04/2021

(3 ways to decide on the right route for you)

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

We have an interesting view towards debt in the UK.
It tends to be that we should be rid of our mortgages as soon as possible…at the very least by the time we retire. And quite right.
Did you know the German word for ‘debt’ is the same as ‘guilt’? When it comes to mortgages, we 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 factors play into making a decision on the right route for you though.  Here are the three big factors we think you should consider:

Do you have other debt?

Some clients may have other types of debt, such as student loans or credit cards, which are very expensive to carry.
Interest rates on credit cards tend to be around 20% per annum- significantly higher than your mortgage interest rate.
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, it’s best to find out and keep on top of it!
As mentioned previously, you could be on a low rate, as interest rates have moved down steadily over the last 40 years. Back in the late 70s until the mid 80s interest rates were no lower than 10%. In 1979, the Thatcher Government raised them to 17% to combat inflation in the UK.
No wonder everyone had interest-only mortgages at the time!

So if your interest rate is low, your mortgage payments are very affordable and you have minimal debt then investing may be a good alternative. 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 with 60% invested in global shares, and 40% in lower-risk such as government bonds, has shown average annual returns of 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?

Big Fat Disclaimer

The massive disclaimer here is 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! We would say however that returns are still likely to exceed 1.5% in a medium risk investment.

Interest rates could begin to move up. This seems unlikely in the medium term given the level of borrowing both governments and households have. But a return of inflation may force interest rates up sooner than we expect. Meaning you would end up paying more on your mortgage. So any additional risks such as investing would not make any sense. Paying down your mortgage therefore would be a no brainer.

What are you keeping your money liquid for?

When we say ‘liquid’, we 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 up for a holiday home?
Planning for a worldwide trip or 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. If you do aspire to own property (or more than one) and need savings to fund it, paying down more of your current mortgage may make it difficult to extract your savings back out to fund your aspirations.

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.

We started this article by mentioning that each and everyone of you are all going to be different.
Both 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 in life. 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)