Hello and welcome back to Mortgage Advisor on F.I.R.E. This week I will be talking about overpaying on your mortgage.
It’s often difficult to know what to write for this part of the blog, now that we have been in a lockdown for several months. Life has taken on a routine of working, sleeping and eating. I miss restaurants, and holidays. I miss being able to sit in a cafe and have a conversation with someone that is not taking place via a video call. I do wonder how life will look in six-months or a year, and whether we will ever go back to “normal” again. A lot will depend on whether an effective vaccine can be developed, but there is not just the health impacts of this virus to contend with but the economic and societal impact as well. Those impacts will last for years, if not decades.
In the last few days it was reported that the UK government borrowed £62 billion in April 2020 to help with the economic impacts of the coronavirus. Further projections suggest the government may have to borrow almost £300 billion by the end of 2020. I doubt the UK is alone in this, but the money will have to be repaid at some point in the future. One of the main ways the government borrows money is through issuing new bonds. Investors buy bonds which pay a coupon (interest) every six months and when the bond matures, the government pays the value of the bond back to the investor (note: it’s generally more complicated, and the value of bonds is not always static and can change with inflation, for example).
All this money will have to be paid back somehow, and I think it’s inevitable that taxes will rise in the future. I don’t think we will see major tax increases in the near future though, as if people are not working they can’t pay income tax. I think it’s more likely that the debt will continue to increase for another 5-10 years, at which point we will see those taxes increase. The tax increases may come in the form of an increase the percentage rates for each band, or what I think is more likely is that the bands may shift with the threshold for the higher rates of income tax coming down. It’s going to be a tough time, economically, over the next decade.
We have finally started booking viewings for potential BTL purchases. It’s an exciting time, but dealing with some agents has been challenging to say the least. There really is a massive range in quality when it comes to agents. Some of them are knowledgeable, friendly and efficient. I’m sure at some point I will speak with one of these mythical creatures. In all seriousness though, some of the agents I’ve spoken with this past week have been very helpful. There have been a couple that have tried my patience, especially when it comes to their Covid-19 viewing policy. My JV partner and I live in different households and we are keen to make sure the viewings are as safe as possible. We are happy to enter the property one at a time (we are primarily looking at empty properties for now) and most agents have agreed to this, on the condition only one of us is in the property at any one time (sensible) and that we wear masks and use hand sanitizer (sensible) and that any discussion around the property takes place outside or over the phone (sensible). One agent has stated we need to book two different viewings and that he will have to make two different journeys to the property (not sensible - fucking stupid). I’ll let you know how the viewing goes next week.
Current Weight: 116.3kg (down 0.5kg from last update).
Current Body Fat: 41.2% (no change from last update).
BMI: 35.1 (down 0.2 from last update).
Weekly Goal: lose 0.75kg
Ultimate Goal: 90kg
I’ve lost 0.5kg this week which is a step in the right direction. My body fat and BMI hasn’t really changed though. I want to increase the rate of loss, but I’m aware that crash dieting is not the answer. I’m going to try losing 0.75kg each week moving forward. That rate of loss should see me hit my target weight in 36 weeks. Again, I’m fully aware that weight loss rarely follows a linear path. The key is to keep making progress week on week.
Premium Bonds: £15,700 (up £600 from last update).
Stocks and Shares ISA: £8,336.40 (up £193.02 from last update).
Fuck It Fund: £5,050.49 (up £25.00 from last update).
Property Value: £181,626 (no change from last update).
Total Assets: £209,894.87 (up £793.02 from last update).
Residential Mortgage: £144,372.10 (no change from last update).
Total Debts: £144,372.10 (no change from last update).
Total Wealth Figure: £66,340.79 (up £793.02 from last update).
Investment Income in 2020: £31.44 (no change from last update) (target £2,000).
I hit the initial target for my Fuck It Fund a few weeks ago, but I’m still continuing to drip feed money into that pot. It makes sense to build up a decent cash reserve, so I will continue to put a few pounds in here and there. The main thing is that I don’t dip into that pot unless it’s an absolute emergency.
The stock market, or at least the parts I’m exposed to, appears to have found some sort of stability. The value of my ISA has remained fairly constant for a few weeks now with just minor gains and losses from week to week. I’m happy to see it continue at a low level for the next few months as I’m able to buy units for a lower price. Over the next few years and decades, I’m sure that my financial comfort at that point will be due to having the means to snap up shares at a lower price now. As the saying goes, you make your profit when you buy, not when you sell.
Overpaying on your Mortgage
Note: the next section uses hypothetical examples, and although I argue in favour of not overpaying on your mortgage, I don’t know your individual circumstances. This is for information only, and does not constitute advice or a recommendation. Before committing to a particular course of action, whether that be overpaying on your mortgage or investing the money you would have used to overpay, seek expert advice from a qualified finance professional.
Conventional wisdom dictates that paying your mortgage off early is a wise move, because it decreases the interest you incur and leaves you in a better financial position. In isolation, this statement is true; paying your mortgage off early reduces the interest charged over the life of the mortgage. However, your financial life does not operate in a vacuum. Last week I talked about opportunity costs and how spending money on one thing reduces your ability to invest and see returns on the money years later. It’s a similar concept with overpaying on a mortgage. As is often the case with financial concepts, it is best explained with an example.
Let’s look at a typical mortgage of £200,000 that is taken out over a 25-year term on a rate of 3%. For the purposes of the example, I’m going to assume that interest rates remain the same over the term of the mortgage. This is unlikely, but as inflation and rate changes apply to both debts and assets, it balances out.
The mortgage payments will be £948 per month, with a total amount payable of £284,478. Assuming that you increase your payments to clear the mortgage in 15-years, you will have to pay £1,381 per month; an increase of £433. The total amount payable would reduce to £248,583. Paying the extra £433 per month, saves almost £40,000 of interest and you’re mortgage free in 15-years rather than 25-years.
It really gets interesting though, when you look at what happens if instead of overpaying £433 per month, that money is invested. It’s widely accepted that annual stock market returns over time average out at around 8%. Obviously, some years are better than others. I’ll be conservative and assume a 5% annual return. After 15-years of investing £433 each month, and assuming a 5% annual return, that investment will be worth over £120,000. If you were to keep investing the £433 for 25-years, your investment would be worth around £260,000.
Which scenario looks more attractive? Option 1; overpay and save approximately £40,000 in interest and ten-years of mortgage payments. Option 2; pay the mortgage off over 25-years and take the hit on the interest, but have investments worth over a quarter of a million pounds? Well, before you decide, there’s something else to consider and it’s an important part of the calculation that people often overlook. I’m talking about the other opportunity cost.
If you pay your mortgage off 10-years early by paying the £1,381 each month, which means for the 10-years after the mortgage ends you can invest that money instead. £1,381 invested each month for 10-years with a 5% return will produce an investment value of £215,000.
Let’s compare the two examples side by side:
Example 1 - paying the mortgage off over a standard 25-year term
Mortgage debt: £200,000
Monthly payment: £948
Total amount paid: £284,478
Investment monthly contribution: £433
Total amount invested after 25-years: £129,900
Projected value of investment: £258,930
Total payments towards mortgage and investment: £388,830
End result: property owned outright and investment worth £258,930.
Example 2 - paying mortgage off over 15-year term
Mortgage debt: £200,000
Monthly payment: £1,381
Total amount paid: £248,583
Investment monthly contribution: £0 for 15-years, then £1,381 for 10-years.
Total amount invested after 25-years: £165,720
Projected value of investment: £215,338
Total payments towards mortgage and investment: £414,303
End result: property owned outright and investment worth £215,338
In example 1 your investment increases in value by 99.33%
In example 2 your investment increases in value by 29.94%
In example 1 your investment increases in value by £129,030 but you pay £35,895 more interest on your mortgage.
In example 2 your investment increases in value by £49,618 and you save £35,895 in interest.
For me, in this example, it’s crystal clear which option is more favourable. However, this is based on the numbers alone without considering the unique circumstances for each person. A married couple with three kids, might want the security and peace of mind of paying their mortgage off early. I get that. Perhaps for that couple, a middle of the road approach would be better, such as paying the mortgage off in 20-years and investing the difference.
Consideration also needs to be given to the relative rates of interest. I based my examples on a mortgage rate of 3% and an investment return of 5%. At the time of writing, it’s possible to get a new mortgage with a loan-to-value of 85% for 2% or less. The historic rate of return from the stock market is closer to 8%. I’ve rigged the numbers in favour of support paying the mortgage off early, but even after doing that it still becomes clear that it’s generally better to invest rather than paying your mortgage down. I cannot stress strongly enough that this example does not take into account your own specific circumstances. Before you make any decisions, seek expert advice and crunch the numbers yourself.
Thank you for reading this week, and I hope you have a great week ahead. If you are following F.I.R.E. or would like to know more about it, please get in touch via Twitter (https://twitter.com/NowWeLive01) or leave a comment on this post.