Ask the Horde: Overpay The Mortgage?

Howdy,

I had a few comments asking why I was overpaying my mortgage, in these low interest rate times.

Surely the money would be better put to work in the markets, in the long run this should be expected to provide returns in excess of the interest I’m saving on the mortgage.  So what am I doing?

The Finance Zombie - Confused

Up Yours, Debt

It’s true, interest rates are low.  On top of that I get a super cheap mortgage from my employer.  And better still, I bought my house in 2009 when house prices were a pittance compared to now.  So my mortgage is relatively small and the payments are killer.

Despite this, I’m still overpaying each month.  One of the reasons is that, even if it is cheap, it’s still debt.  And I don’t like debt.  Currently, Mrs Z and I are postured up, battering the debt into submission.

It’s So Cheap

Yep, I’ll admit it.  I’ve got a pretty sweet deal on my mortgage.  Even after being taxed for the benefit it comes out as a very low rate, not quite the best, but there or thereabouts.  To get the best rate on the market would mean moving provider every few years and so incurring fees.

Any many limit when, and how much, you can overpay.  Like a Mortgage Vagabond, I can do what I want (as long as that involves paying the bank some money).

As good as it is, it’s still a tie to my current employer.  Paying the mortgage off would remove the invisible shackles to my desk.

Locked In

The likelihood is that if I deployed savings to the market, instead of overpaying the mortgage, I’d never then get round to selling investments to eventually pay off the mortgage.  End result…less freedom.

In 10 years time I’d admittedly have more in savings, but I’d still be looking in the Financial Shadows with an unnerving feeling that wherever I went creepy Mr Mortgage was watching.

If the plan was to then use savings to pay off the mortgage, but markets had taken a tumble the plan would change.  One More Year Syndrome here we come.  I’d like to avoid that if possible, please.

It’s Diversification, Innit

I already put a fair whack into the markets each month, through my pension and ISA contributions.




Scattering my Savings Net a bit wider, and overpaying the mortgage, is essentially diversification (if you think of the mortage as a huge negative cash position).  I’m already maxed out on all the best interest paying current accounts or savings accounts.

The ISA Limit Is The Limit

Mrs Z and I are already saving enough to max out our ISAs by the end of the tax year, so there’s nothing to be gained here.

It would be the first place I’d put extra savings if there was any allowance left.

I could up my pension contributions, which is probably the most efficient move.  But I can’t access that until I’m nearly 60 and I already put in 21% a month (including employers contributions), which feels enough.

Maybe The Mortgage Isn’t All Bad

There are certainly some strong arguments to just pay the minimum on the mortgage and save instead of overpaying.

Fear Of Missing Out

In the long run, the expected returns of investing in the market are greater than the savings I’m making in interest on the mortgage.

If we assumed a 4% return on investments, versus a 1.1% interest rate saving by overpaying the mortgage, on a £500 overpayment for 10 years the difference is around £10k.  So I’d be £10k better off in 10 years time if I invested in the markets instead of overpaying the mortgage.  Certainly not an amount to be laughed at.  Unless you’re so minted you wear stupid hats.

"Look at Mr Z fretting of £10k"

“Look at Mr Z fretting of £10k”

There’s a glaring issue with this, glaring so bright it’s fried my retinas.  The savings on overpaying the mortgage are guaranteed (OK, the rate may vary, but it’s only likely to increase) whereas the 4% is an assumed growth rate.  It could well be smaller than 4%, or even *swoons* negative.

I’m happy missing out on those potential returns in exchange for suplexing my mortgage into oblivion.

Rock Solid

It’s not particularly easy to access equity in a house.  Once I’ve made an overpayment, the cash is then sat in bricks and mortar, I can’t just remove a brick from the house and cash it in at the bank for a few hundred quid.  It loses it’s liquidity.

There’s a sacrifice being made here, reducing future interest payments and my tie to my employer/the bank in exchange for a reduction of liquidity.

I don’t benefit from the overpayments, really, until I sell the house (so releasing monies) or the mortgage is completely repaid (so improving my cashflow).

Which I why, although making some overpayments, I am still saving more than I overpay.

The Right Decision?

It makes sense to me.

If I had more ISA allowance to go, I’d put money there first, but it’s all used up.  My pension contributions are already high enough, in my opinion.  I’ve deployed cash to the best rates on the market and maxed them out, so there’s not much to be gained from holding even more cash.  There’s also a taxable share dealing account I put a bit towards each month, but I don’t want anymore in there.

Current overpayments leave me mortgage free in 10 years.  That does still seem like quite a long time, but increasing overpayments further would start to hamper liquidity.  Some quick sums show me that my savings/investments should outstrip my mortgage in about 21 months…

Just thinking about being mortgage free

Just thinking about being mortgage free

A decision will have to be made when that happens, as being mortgage free in less than two years is pretty tempting.  Then again, effectively starting savings all over again would be brutal.

So To You, My Friend

Right, it’s Saturday night and I’m off to do what any awesome dude does on a Saturday.  Hit up a casino.  Play a board game with some friends.

Where do you stand on overpaying the mortgage?  And why?

Mr Z

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31 thoughts on “Ask the Horde: Overpay The Mortgage?

  1. JoeCrystal

    I have to agree with your assessment.

    I am overpaying my mortgage as much as I can to 10% per year and I can do it while I got money to spare. Every pound I overpay, less I would need to pay in the long run. I don’t know what my future may bring but I will be more comfortable in asking my monthly payment to be adjusted so there is lower monthly payment for the rest of the term in case of losing my job and so all.

    Reply
    1. Mr Zombie Post author

      I hear you, JC. It’s pretty much a guaranteed return, which is nice. While the cash is flowing, divert it to the mortgage. Boom.

      Mr Z

      Reply
  2. David

    Hi Mr Z
    I’ve spent a long time pondering the same conundrum. All the experts say that interest rates will remain low for a very long time and equity returns are not going to be much higher. But the experts have recently been wrong about a whole load of things and will probably carry on being wrong… unless they’re right. You might even say we’ve ‘had enough of experts’!
    My revelation was coming to appreciate that my house isn’t really a proper asset, because realistically I’m unlikely to ever sell it without buying another one of at least the same value. It’s a bit like my second kidney really. It’s technically possible for me to exchange it for some cash, but that would lead to other problems. Therefore I don’t look up its value on the internal organs equivalent of rightmove and include it on my net worth spreadsheet.
    More seriously, once you accept this fact, conventionally sensible decisions like adding value to your house by building a massive extension don’t necessarily make sense, because they take away a big lump of your savings (or, perish the thought, add to your mortgage debt) without providing a corresponding asset on your personal balance sheet that’s going to provide you with a return on your capital, let alone a return *of* your capital.
    Moving onto practical matters, one option you could consider is an offset mortgage with one of the few lenders who allow you to use your ISAs as the savings element. Seems like that would give you the best of all worlds, as you would keep the tax free status of that massive slug of savings, you would cut your debt levels whatever happens to interest rates, and you’d also retain the optionality of being able to draw down on a large facility if stocks were ever priced a bit more reasonably.
    Personally I doubt we’ll see ISAs survive in their current form indefinitely (i.e with no lifetime allowance), as allowing 0% tax on such vast sums of ‘unearned income’ doesn’t sit well with the new government’s declared priority of helping the JAMs – but that’s another story.
    Hope that helps!

    Reply
    1. Mr Zombie Post author

      Thanks for the detailed comment, David.

      On the house not really being an asset, I guess it depends where you’re at. Halfway through paying off a mortgage, you’ve not really had much benefit (except maybe monthly payments not rising as fast a rent…). A house paid off and then you certainly have an asset, your cash outgoings reduce significantly as the mortgage no longer needs to be paid. Hoot!

      I too like my second kidney. Where the house could be really useful is protecting you from capital gains tax, buying more house than you need to benefit from tax free capital appreciation. Certainly not a route I would want to go down as it’s so inflexible (and not at all guaranteed). Indebting yourself to build more house than you need is pretty silly. On the other hand, buying a house, living in it while doing it up (and extending it yourself), selling and moving on is a good, if not really fecking tiring and risky, plan.

      Good point re: the offset mortgage, and it’s probably the route I would take if the beneficial loan my employer offered wasn’t so nice. It’s a shame they don’t offer an offset option on it, it would be perfect!

      I too am suspicious about where the ISA vehicle is heading, and surprised that annual allowances have increased so much without a hint at any lifetime allowance. Until then, I guess we all pile in.

      Thanks for the comment, it always helps to see others opinions 🙂

      Mr Z

      Reply
  3. weenie

    Sounds to me that you’ve got a good balance – maxing out your ISAs and putting enough in your pensions for tax advantages AS WELL as paying down your mortgage.

    Low interest rates will not remain forever and as you take chunks off your mortgage capital, when the interest rates go up (and they will go up at some point), the kick in the teeth will be somewhat lessened.

    Reply
    1. Mr Zombie Post author

      Hi Weenie,

      A balance is what I was aiming for. I know some have really attacked their mortgage and paid it off in 2 or 3 years. But the lack of liquidity creeps me out, to be honest!

      True on the interest rates, and if that does happen and I’d just been saving, I know that I wouldn’t then transfer savings over to the mortgage. It’d be too painful to do in one swoop.

      Mr Z

      Reply
  4. Ryan

    It never even occurred to me to do anything other than pay my mortgage off as fast as possible. So I did, and now it’s gone I save and invest. I don’t regret doing it that way around for a second. I hated having any debt, and a mortgage was the only debt I couldn’t avoid. For me, the certainty and security of having paid it off far outweighs any possible “better” outcome which would be far from guaranteed.

    Reply
    1. Mr Zombie Post author

      That is some awesome work, Ryan.

      Did you have anything to protect you, in the form of liquid savings? Or was it just a great balls of fire all out assault on the debt? The lack of liquidity is what puts me off that approach. (That and my balls just aren’t big and fiery enough)

      Mr Z

      Reply
  5. Steve

    I think there’s always an element of “what makes you happy” in this – we’re not emotionless robots, *nor are we all emotionless in the same way*, and if the mortgage bothers you, then even if (which I don’t think is the case) we could *prove* it was a poor choice to pay it off first, you’d be well to consider paying it off earlier anyway. (Unless of course that hypothetical proof was sufficiently convincing that your emotional reaction changed…)

    I found your arguments compelling and well thought through, but that’s possibly because they fit my own preconceptions. Due to a series of quirks in the course of my life – primarily that I bought my first property relatively late in life, despite earning a decent salary for many years before – I’m essentially in the position where I have enough money in my ISAs and SIPP to retire on, *except* that I need to finish paying off my mortgage. However, I think in your position I’d do more-or-less what you’re doing – max out the ISA, make a decent SIPP contribution but don’t go overboard as it’s not accessible early enough for early retirement, and then put whatever’s left against the mortgage.

    To state the obvious, the downside of liquidating your ISAs to pay off the mortgage once they outstrip it is that you “only” (yes, it’s actually quite generous; one of the nicer parts of our tax system) get a £15k allowance per year. By liquidating it you’re “losing” the last n years of ISA allowance you used to build it up. The money itself is fungible, but the ISA allowance is not. If you earned a lower salary and couldn’t contribute more than the ISA allowance per year that factor wouldn’t exist, but fortunately for you it does.

    Reply
    1. Mr Zombie Post author

      That’s some good commenting, Steve.

      You’re right, if it was 100% prove-able, with countless peer reviewed papers and random celebrity endorsements, that what I was doing was the guaranteed wrong choice, then things would be different. Wouldn’t necessarily make me change my choice, but it would alter the weightings of my choices.

      Good man, nothing like a bit of confirmation bias to keep us happy 😀

      Having money locked away in a SIPP is a pain, but that’s the premium we pay for the tax benefit.

      It does sound like you are in a similar position to which I hope to find myself in, in a few years. And I suspect I will think similar, let the ISA beast be as the tax benefit are just lovely. Perhaps start paying down the mortgage even more, who knows. Or do something else that will cover the bills while the ISA and SIPP continue to swell… What are you plans, if I may be so bold?

      Thanks again,

      Mr Z

      Reply
      1. Steve

        Until the glorious moment of pulling the trigger, I plan to keep my head down at work. The vast bulk of my savings will go against the mortgage – I have an offset mortgage, so I’ll retain some liquidity and (to use Ermine’s phrase) I can be my own “lender of last resort” once I’m FI and deemed a terrible credit risk. I’ll be on the standard variable rate by then, but even that’s likely to be way better than a credit card and probably even an unsecured bank loan.

        However, I will continue making SIPP contributions as I just can’t pass up the tax savings, and depending on exactly how things pan out I may well make ISA contributions too.

        I expect to pull the trigger in summer (not *next* summer, alas!), just because that’s when the mortgage will be paid off according to my projections, so I’ll probably take a few weeks/months to just “do whatever the f* I want” here in the UK 🙂 – I imagine this will involve experimentally living without an alarm clock, if nothing else! In order to stave off sequence of returns risk I hope to find some kind of “side gig” (not that it will be a side gig by that point, but you know what I mean…) – perhaps freelancing related to my current line of work – and will probably poke around at that in a low-pressure way after the initial bout of pure freedom.

        I can see the value in starting to build up a side gig right now, but I don’t want to be paying tax at my marginal rate on the side gig income, not to mention all sorts of onerous restrictions on outside business interests imposed by my current employer, and the fact that my job – while pretty cushy, all things considered – takes up enough of my time that I’m reluctant to burn any of my precious free time for a low rate of return.

        The idea of retiring *now* and relying on a side gig to earn say £10k/year is tempting, but given my job pays pretty well and I’ve less than two years to serve if all goes to plan, I think I’d rather suck it down and be 100% FI then rather than be 90% free now but be under an obligation to earn £10k/year somehow year in, year out. I’d much rather be working the side gig just as a bonus, knowing that I don’t *have* to do it if I’m willing to live fairly frugally.

        I hope to do some low budget travel once I’m FI, but my current thinking is that I’ll leave that until the winter – I’ll be much more comfortable with blowing money on such luxuries if I’ve been able to get *some* side gig income going. Plus I always think it’s nicer to go abroad to get away from the UK winter than to do it in summer.

        I hope that’s not too much detail. As you can tell, I’ve hardly given this any thought at all, really. 🙂

        Reply
        1. Mr Zombie Post author

          That’s a good point, as soon as you’re out of work getting any kind of finance can be a pain, as it’s based on your income, rather than assets.

          I suppose it’s a weird thing, ‘early retirement’. Just by definition it encompasses normal retirement as well. So, at some point, you’re going to benefit from your personal pension savings and all those tax savings.

          So the summer after next? Nice! I wonder the same thing, if at some point there is some kind of bridging business I could start up. It would be nice to start something, with the assets of being 90% of the way to FI behind you should it all go up in flames. Even then, you’d still be very employable in your old line of work anyway.

          Haha – that’s all good. I suspect, for most, it’ll take a few months at least to figure out what you want to do. And once you got all that free time, you’ll start to make money pretty swiftly, I’m sure.

          Good luck!

          Mr Z

          Reply
  6. Berry

    Once in a while it’s so good to take a step back and observe the discussion on these forums. We are all wondering if it’s better to save, invest or pay off our morgage, in what mix one should do that etc. Where the rest of the world, just thinks “Whaaa another pay check, what useless crapc an I buy now! Mortgage? Pension? Savings? Nah, I’ll just have the shiny thing with an apple on it.”.

    In other words; you’ll be fine either way. And yes, I fully agree, we have also always overpaid our mortgage quite a bit and even though we’ve only been paying for 5 years and we don’t have loads to overpay, it motivates extremely to see that our monthly payments have already gone down by almost 10%. (Which leaves room to overpay even more :))

    Reply
    1. Mr Zombie Post author

      Haha, good point, Berry.

      (Mmm, apples)

      I suppose part of the reason we are where we are, is precisely because we think like that. We are the geeky 1%.

      Yeah, that is awesome. I must admit, I do enjoy peeping at a graph showing where my mortgage would have been with no over-payments and where it actually is, and marvelling at how quick the gap grows.

      Mr S

      Reply
  7. London Rob

    Hi Mr. Z,

    I pretty much echo what others have said above. You are maxing out your ISAs first (to me the most important part as they are a use it or lose it limit) – although this may be more challenging next year when the allowance goes up to 20k per person. Interesting comment above by David in terms of will the ISA stay the same. I really hope it does, the government needs to keep it consistent for those of us saving to not be a burden on the state. I expect that their aim is to remove pensions and get people using ISAs only – after all you are taxed on the way in. I would hate to see any form of allowance – especially ones that are based on the total value so if you invest well or are lucky you get hammered.

    Whilst you are putting a fair whack into your pension, I will assume its not up to the max 40k (or adjusted amount) that you could put in. It depends where you are in the tax bracket for me on this – if you have to keep upping it to stay in a lower tax bracket (e.g. just under 40k, or the 50k child benefits etc.) then I would increase pension contributions. If not, then why worry.

    Then I would do as you are doing – hammer the mortgage and get a better cash flow. The faster you can get it down the better. The other option would be to split your overpayments, assuming you can utilise the 5k limit on dividend income, you could use half to overpay the mortgage, and the other half into a tracker paying out, and take the cash from that to overpay the mortgage as well.

    Ultimately it comes down to what enables you to sleep best at night (and I dont mean a bottle of whisky or some drug or other!)
    Cheers,
    London Rob… aka…. …. ?

    Reply
    1. Mr Zombie Post author

      Hi LR,

      Agreed, makes sense to me, keep trying to hit that ISA limit. It is an interesting point you raise, as much as the ISA is a tool to encourage us to save, it is a burden on the state. All that lost revenue.

      Like you say, I think they are sacrificing future tax to get some tax now, but making the restrictions on pensions a bit tighter and dressing the ISA up in a boob-tube.

      Bang on, I’m not at the £40k annual allowance. Nowhere near, but you have to be really raking it in to get near it. I could up my pension contributions to get myself out of the 40% tax bracket, but that would be at the expense of ISA/other savings…not keen at the moment (but I am keen to up it everynow and then).

      Your last point is bang on, it is individual, and what’s “best” for me might not be best for you (or even what is statistically the best choice economically). That’s why it’s good to discuss.

      AKA…?

      Mr Z

      Reply
      1. FIREin' London

        Hi Mr. Z,

        I would make sure that you hit the limit as fast as possible, thats certainly what I would like to do if possible, but the revenue is only lost if you never spend it. Think of the additional support that people who are self sufficient would provide without having to burden the state. And dont forget, thats more money being spent in the shops or food potentially which would add to the VAT take…
        I really hope they keep the ISA as is for now, and let us continue to sock away the money to keep topping it up.
        If you are in the right place to fill the ISA it has the advantage of meaning you can get at the savings – or maybe each time you get a pay rise put some of that in (e.g. 4% pay rise, put 2% into the pension).

        At the end of the day – yes you have to be happy and sleep at night and be comfortable with it – even if it isnt the most efficient way to do it. Im trying to get as close to being as efficient as I can 🙂

        AKA I started up a blog as well 😉
        LR

        Reply
        1. Mr Zombie Post author

          I wonder how many people are maxing out their ISA’s…I always thought those of us that do are oddities! I’ve never seen any stats or anything to back it up.

          In part, yeah, just being efficient does make me happy (and I suspect many of people on the path to FI are this way inclined too).

          Aha! I see. Time to check out your blog…

          Reply
          1. FIREin' London

            I do recall somewhere that the numbers maxing out are very low, and it was something like 3k on average going in (although my memory may be hazy…!) – I suspect that was just averaging it out across the board…

            You are right – its how people feel happy. I’ve learnt to live with being more efficient, even though I would prefer to pay down the mortgage, I know I will be better in the long run!
            Oh no…. the pressure! 🙂

  8. John B

    I’d overpay. After all, no-one ever suggests the reverse, increasing your mortgage to invest in the stock market, as borrowing to invest is very dangerous.

    Reply
  9. BigglesMcGee

    One additional benefit in many mortgages is that regular over-payments are often able to be ‘drawn down’ in the event you have a period where you can’t pay the mortgage. If you overpay you mortgage by 10% each month then, each year you do so, you buy yourself > a month of ‘cover’ in the event you end up in a cashflow bind and can’t pay the mortgage – very helpful to avoid arrears, credit rating hits, and defer any really big issues like repossession.

    Reply
    1. Mr Zombie Post author

      Mr McGee,

      True true true, that is a helpful feature. Know if it is penalty free?

      You can get yourself in a similar(-ish) situation by taken out a mortgage for as long a term as you can and then overpaying to get rid of the thing in a few short years. Assuming the bank let’s you do this without any penalties, it’s a good plan, and the situation I find myself in. Then, if money does get short in the future, you don’t over pay. You have built yourself some wiggle room. Got to be disciplined to make it work, and not just end up paying the minimum for 40 years…

      Mr Z

      Reply
  10. lobber

    I have a different take on it, which is that you never know the future and what it brings. While some say that the smart thing is to save/invest while rates are low, there is the other side of the coin which is ‘what if I become ill or something happens that stops me being able to pay the mortgage?’. While you’re young its not something that you really consider as you tend to be fit and healthy. However, illness can and does happen (as it did to me 5 years ago at 38), and by paying off the mortgage sooner it was a relief not to have to worry about it, knowing I had a roof over my head regardless of how ill I was and with no worries of meeting payments, especially as my salary dropped to the statutory minimum after 6 months off.

    It’s a fine line to balance, I always overpaid, not the maximum I could, but enough to reduce the term drastically yet still allow me to save/invest for the future.

    Reply
    1. FIREin' London

      Hi Lobber,
      For me this is where insurance comes in – so if anything were to happen to me (death, critical illness etc.) we would receive a lump sum that would clear the mortgage, the equivalent of about 80% or more of my salary, and another lump sum for care. Possibly I am over insured on that, and its something I want to reduce as I build savings but for me that means I dont have any worries – I need to be able to last 3 months and then it kicks in between them they go until retirement from memory.
      I do like the idea of reducing my mortgage further though as this makes my cash flow better!
      Cheers,
      FiL

      Reply
    2. Mr Zombie Post author

      Hi Lobber,

      Sorry to hear about the illness, that’s tough.

      At the moment, Mrs Z and I can cover our living expenses just on one salary, so we tend to think of ourselves as “insured” in a way. Naive, perhaps?

      Good job on paying off the mortgage 🙂

      Mr Z

      Reply
  11. theFIREstarter

    Hi Mr Z,

    Good question and one that will rage on between PF bloggers for years to come no doubt.

    As always it is down to your own situation and personal preferences.

    Have to say if I were in your situation I would do exactly what you are doing, you’ve played a perfect hand I reckon.

    On the flip side, we’ve just locked in a 10 year mortgage at 2.49% and will not be paying any extra off at all if we can help it. Reasons being:

    We are no where near filling up our ISA allowances each year.
    I want to work less now (and in fact am already doing so) so need more cash flow rather than tying it up in bricks n mortar.

    Maybe if it gets to year 7 and rates have gone up to 10% we will get on the overpayments ASAP! But it all depends on what they do. Having said that if rates were 10% it would probably mean inflation has smashed into whatever left we owed so even then maybe it wouldn’t be worth over paying – that is another thing to consider as well of course! 5 years of 10% inflation and my mortgage is practically cut in half. Sure there would be other dire consequences but every cloud and all that 🙂

    Cheers!

    Reply
  12. WestCountryEscapee

    As a freelancer, I’ve switched my mortgage to interest only for this year because I’m buying an investment property which involves taking money out of the company and want to stay below higher rate tax.
    Longer term, by not overpaying I can divert more money into my pension (which I usually max out). I can then get my 25% free in eight years and this may be enough to pay off any remaining capital.
    Although the government is eroding the SIPP benefits (e.g. the lifetime allowance) I think there may be advantages to maintaining some mortgage debt…

    Reply
  13. Maciej

    Recently on r/financiaindependence there was discussion about overpaying mortgage and someone put it that way.

    Would you take £100 000 loan at 4% and put it in the market and be happy with yourself? If answer is yes then don’t overpay your mortgage. If answer is no then overpay your mortgage.

    I am in fixed 3.69% mortgage right for next 2 years. I choose to overpay most of my savings into it because:

    1. I don’t believe interest rate will stay that low for ever especially with approaching brexit etc.
    2. Cash flow – having paid of mortgage means my cash flow increase by nearly £500 having actual cash flow allows for much more flexibility than money locked in the market.
    3. Doesn’t matter what happens my family is save for having a shelter. With mortgage paid we are able to survive on one income so one of us can loose a job and we don’t have to dip into emergency saving.

    This 3 reason are more than enough for me to choose overpaying mortgage even if mathematically speaking it’s not the most optimal decision.

    Reply

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