How to know when to invest or overpay your mortgage
Is it better to be debt free or have a healthy Isa balance? Alexa Phillips does the sums
Banks are being bombarded with inquiries from homeowners who want to overpay their mortgage as a way to fight rocketing rates. Santander, one of Britain’s biggest mortgage lenders, said there was a 40pc rise in requests for overpayments in the week following Kwasi Kwarteng’s minibudget, which spooked the financial markets and sent interest rates on new home loans soaring. But is overpaying your mortgage the right thing to do, or is there a better use for your money? Most mortgage lenders allow customers to repay 10pc of their mortgage balance each year without having to pay an early repayment charge. This can be done as a regular monthly amount or as a lump sum. Borrowers with more equity in their property may be able to secure a better rate when they come to remortgage. The best two-year fixed deal for those remortgaging with a loan worth 75pc of their home’s value was at 4.36pc on Friday, compared with 5.1pc for loans of 80pc, according to Defaqto, an analyst. Mortgage rates have rocketed as lenders anticipate further increases to the Bank of England’s official rate. The average two-year fixed rate rose from 4.74pc on the day of the mini-budget to reach 6.16pc on Friday, according to Moneyfacts, another analyst. Falling returns from the stock market at the same time as mortgage costs rise mean it can make financial sense to make overpayments. Roger Clarke, a financial adviser at The Private Office, said homeowners should pay off their mortgages if they had extra cash available. “The only reason you wouldn’t do that is if you thought that you were going to make an investment return that is going to be higher than the interest you’re paying on your mortgage,” he said. Now that mortgage rates have doubled, paying down loans can have a big effect. For a borrower with a £320,000 mortgage at 5pc interest and a 25-year term, overpaying by £200 a month would save £46,987 in interest and result in the debt being cleared four years and four months early, according to the broker L&C Mortgages. By comparison, on a rate of 2.5pc the interest savings would be £19,194 and the mortgage would be paid off four years and one month sooner. However, one unknown factor is the future return on investments that you would be giving up by overpaying. Pete Matthew, an adviser at Jacksons Wealth Management, said investing was more likely to generate higher returns. “It almost certainly makes mathematical sense to invest rather than overpay,” he said. “But the psychological benefit of overpaying your mortgage is incalculable.” The average fund whose remit is to invest up to 60pc of its money in stocks has returned 6.9pc over the past five years. But this figure was depressed by plummeting returns during the pandemic, said Mr Matthew. Between 2014 and 2019 the return was 27pc. “That’s a simple annual return of 5.3pc, which would have easily outperformed any saving on a mortgage,” he said. He said those still on a low mortgage rate for another year might be better off putting their money into saving accounts, such as one-year bonds, which offer guaranteed returns, unlike a stocks and shares Isa. Those with an extra £10,000 who are on a mortgage rate of 2.5pc, for example, would be better off putting their money into the highest-paying one-year fixed-rate bond at 4.31pc. “That’s a no-brainer,” he said. Quilter, a wealth manager, said higher-rate taxpayers could be better off investing spare cash. A homeowner who invests £500 a month into funds for the next 25 years would end up with £338,000, based on forecasts of 6pc growth a year. By contrast, a homeowner who used the £500 a month to overpay on a £400,000 5pc mortgage would clear their debt seven years and three months earlier than their 25-year term. If they then began investing the £500 a month as well as the monthly amount they no longer had to spend repaying their mortgage, they could grow a pot worth £303,700 by the end of the 25-year period. The advantages of investing are even greater if done via a pension. Quilter said that if mortgage rates averaged 6pc over 25 years, the difference between overpaying and investing was negligible.