Overpay Your Mortgage Or Invest In The Stockmarket?

If you have a mortgage, you probably have a compelling desire to reduce the amount you owe and the number of years you have left to repay. After all, the longer your mortgage lasts, the more you’ll pay in interest and associated life insurance policies.

For most people, their mortgage is their biggest debt, so just imagine being mortgage-free sooner than expected!

However, if you have excess cash and you’d like to put it to good financial use, it may not be the most sensible decision to overpay a mortgage in the current economic climate: it could be more prudent to invest in shares.

Read the pro’s and con’s of the two approaches below.

Rates: Mortgage Vs Shares

There are some very competitive, low-rate mortgages out there at the moment. You’re able to fix a mortgage for 2 years at an interest rate of less than 2% – and that isn’t even for a 60% loan-to-value (LTV) mortgage, but for a 90% loan-to-value mortgage! If you were to overpay on this type of mortgage, you’d save less than 2% in debt servicing costs (the cost to repay interest and principal on the mortgage) per year.

However, for those with higher rate mortgages, overpaying can be an attractive option. The Money Advice Service gives an example of the savings that can be made with a £5,000 over-payment on a £150,000 mortgage with an interest rate of 5%: the over-payment reduces the interest by £11,500 and you’ll repay 18 months earlier too.

Compare those scenarios to the returns you could make investing in the stock market. The FTSE 100 has a dividend yield of 3.9% currently and investing in a tax efficient vehicle, for example an ISA, means that this income won’t be taxed. Additionally, a large number of the companies selling stocks and shares on the FTSE 100 Index give yields of more than 5%, so you’d receive higher income return on shares than you’d save by overpaying your low interest rate mortgage.

Economic Factors

According to Master Investor, it’s increasingly evident that the income return on some shares is substantially higher than the amount saved on overpaying a mortgage. Because of this, a ‘positive foreign currency translation adjustment’ may occur for the international stocks listed on the FTSE 100 index. This will result in an increase in the price of shares – adding to the already relatively high 3.9% income return of the index.

In the UK, the economic outlook is murky because Brexit economic negotiations are “unfolding as a shambles thanks to unforgivable blunders by the Government“, according to Former Vote Leave chief Dominic Cummings. This has led to a weakening of the pound and an increase in the inflation rate – which is now at its joint highest in more than 5 years.

Higher inflation rates usually trigger interest rate rises by the Bank of England, but economists predict no interest rate hikes in the near future as economic growth has to be prioritised. Thus mortgage rates may be low for quite a while yet. This is another factor that makes investing in the stock market more attractive than overpaying a low interest rate mortgage at this moment in time.

The Risks Of The Stock Market

Putting your hard-earned excess cash into shares rather than overpaying a mortgage is an obvious riskier step for anyone to take. Shares can go down as well as up, and the income returns are not certain to exceed what you’d save by overpaying a mortgage.

Nonetheless in the long term the stock market has a total annual return of about 7-8%. As mortgage rates are so low at the moment, with the pound depreciating and economic outlook so unsteady, the stock market may be a wiser investment.

But keep an eye on rates in the future, because if mortgage rates rise substantially, you’d be better off over-paying.

Charges For Mortgage Overpayment

You may get charged for making a mortgage overpayment. Examine your mortgage terms and conditions to check the charges for overpaying or paying off your mortgage early. You’ll need to factor in any charges against the long-term savings you can make. As a generalisation, most lenders will allow you to pay up to 10% a year without enforcing charges.

The Bottom Line

Before overpaying your mortgage or investing in the stock market, consider the other debts you have. Credit cards charge a high rate of interest over the duration of the debt and bank or building society overdraft fees can be steep. If you have some excess cash, clear the expensive debts first and then make your decision regarding overpaying your mortgage or investing in the stock market.