Is It Better To Invest Or Pay Off Your Mortgage Early?

[1632656]

" There's a huge discussion happening both on Lifehacker and Get Rich Slowly regarding the pros and cons of paying off a mortgage early. Contrary to my own assumptions, the numbers (assuming current interest rates around 6%) seem to strongly encourage investing your money instead of paying toward your mortgage's principal.

On the one hand, you get a guaranteed outcome with paying down your mortgage. On the other, a conservative rate of return on an index fund should have no problem beating a 6% rate over the next 30 years. With the variability in people's risk-comfortability, there is no right answer here, but it's informative to hear the personal finance hackers weigh in with their opinions.

Are there any economists in the room that can explain how it's currently cheaper to borrow money and invest it elsewhere rather than to pay off debts? Why would a mortgage company ever lend money in this scenario?

Ask the Readers: Is It Better to Invest or to Prepay a Mortgage? - Link

Pay off your mortgage more quickly to save money - Link

DIY Mortgage Acceleration - Link "

Source: Hackzine

Edited June 4, 2007 by studdymx

[Ignorant Steve]

" There's a huge discussion happening both on Lifehacker and Get Rich Slowly regarding the pros and cons of paying off a mortgage early. Contrary to my own assumptions, the numbers (assuming current interest rates around 6%) seem to strongly encourage investing your money instead of paying toward your mortgage's principal.

On the one hand, you get a guaranteed outcome with paying down your mortgage. On the other, a conservative rate of return on an index fund should have no problem beating a 6% rate over the next 30 years. With the variability in people's risk-comfortability, there is no right answer here, but it's informative to hear the personal finance hackers weigh in with their opinions.

Are there any economists in the room that can explain how it's currently cheaper to borrow money and invest it elsewhere rather than to pay off debts? Why would a mortgage company ever lend money in this scenario?

Ask the Readers: Is It Better to Invest or to Prepay a Mortgage? - Link

Pay off your mortgage more quickly to save money - Link

DIY Mortgage Acceleration - Link "

Source: Hackzine

Hence why IO mortgages are currently so popular. Any "financial planner" (snake oil salesman) can "prove" it's better to use a long term investment vehicle rather than repayment method. But as you said it's all to do with an individuals risk comfort. Personally I'm happier paying down the mortgage in a low interest rate environment tp protect myself from potentially crippling rates later in life.

[se7ensport]

" There's a huge discussion happening both on Lifehacker and Get Rich Slowly regarding the pros and cons of paying off a mortgage early. Contrary to my own assumptions, the numbers (assuming current interest rates around 6%) seem to strongly encourage investing your money instead of paying toward your mortgage's principal.

On the one hand, you get a guaranteed outcome with paying down your mortgage. On the other, a conservative rate of return on an index fund should have no problem beating a 6% rate over the next 30 years. With the variability in people's risk-comfortability, there is no right answer here, but it's informative to hear the personal finance hackers weigh in with their opinions.

Are there any economists in the room that can explain how it's currently cheaper to borrow money and invest it elsewhere rather than to pay off debts? Why would a mortgage company ever lend money in this scenario?

Ask the Readers: Is It Better to Invest or to Prepay a Mortgage? - Link

Pay off your mortgage more quickly to save money - Link

DIY Mortgage Acceleration - Link "

Source: Hackzine

Not exactly a new idea:

http://en.wikipedia.org/wiki/Endowment_mortgage

"An endowment mortgage is a financial product offered mainly in the United Kingdom. It consists of an interest-only loan secured on a mortgage combined with an investment in the stock market. The customer pays the interest on the capital, thus saving money with respect to an ordinary repayment loan; the balance is invested in the endowment fund. ..."

[Fancypants]

Not exactly a new idea:

http://en.wikipedia.org/wiki/Endowment_mortgage

"An endowment mortgage is a financial product offered mainly in the United Kingdom. It consists of an interest-only loan secured on a mortgage combined with an investment in the stock market. The customer pays the interest on the capital, thus saving money with respect to an ordinary repayment loan; the balance is invested in the endowment fund. ..."

of course, SM crash excepted, in a *rising* IR environment, an endowment linked mortgage might do rather well.

[Guest mattsta1964]

" There's a huge discussion happening both on Lifehacker and Get Rich Slowly regarding the pros and cons of paying off a mortgage early. Contrary to my own assumptions, the numbers (assuming current interest rates around 6%) seem to strongly encourage investing your money instead of paying toward your mortgage's principal.

On the one hand, you get a guaranteed outcome with paying down your mortgage. On the other, a conservative rate of return on an index fund should have no problem beating a 6% rate over the next 30 years. With the variability in people's risk-comfortability, there is no right answer here, but it's informative to hear the personal finance hackers weigh in with their opinions.

Are there any economists in the room that can explain how it's currently cheaper to borrow money and invest it elsewhere rather than to pay off debts? Why would a mortgage company ever lend money in this scenario?

Ask the Readers: Is It Better to Invest or to Prepay a Mortgage? - Link

Pay off your mortgage more quickly to save money - Link

DIY Mortgage Acceleration - Link "

Source: Hackzine

I've going for the 'Pay as much of the mortgage off as soon as possible' option.

I'm more interested in knowing my debts will be managable if IR's double than investments at the moment

[MarkG]

On the other, a conservative rate of return on an index fund should have no problem beating a 6% rate over the next 30 years.

Only if you believe that the next 30 years will be the same as the last 30 years. Given that the Boomers are all going to retire and demand massive amounts of money for pensions and healthcare in that time, stock market indices may _drop_ by 6% per year between now and then.

Remember, even those Boomers who have pension fund savings probably have most of their money in the stock market. And to make use of that money they need to.. drum roll please... sell.

And if more people are selling than buying then prices drop. And if more people are selling than buying for years, then prices collapse.

Are there any economists in the room that can explain how it's currently cheaper to borrow money and invest it elsewhere rather than to pay off debts? Why would a mortgage company ever lend money in this scenario?

Because the global financial system is controlled by central banks run by ******ing morons.

It's also worth remembering that Americans get tax relief on mortgage payments and that walking away from a mortgage in America is generally much easier than doing the same in the UK. So it's quite likely that paying off a mortgage there is a poor financial choice.

Edited June 4, 2007 by MarkG

[Tempest]

What people forget in comparing IO mortgages (allowing you invest you principal elsewhere) and paying down principal as fast as possible is that if you pay down your mortgage in say 10 years rather than 25 you then you have (assuming the same cashflows/income for the period) the ability to invest debt free for 15 yrs...I would need to run it through excel but I am not convinced the usual arguments in favour of not paying down early tell the whole story.

Over 25 yrs you compound your investment returns on the capital you invest which you would otherwise pay down but you always have the debt to pay down at the end so that has to be deducted from the overall total return.

If you pay down over 10 years you have no debt but have 15 yrs of cashflow to invest debt free. My instict tells me that 15 years of compound returns of, say, 10% pa after tax is better than 25yrs of returns of 4% after tax and interest (ie the delta between the gross return on investment and the debt interest cost (say 5-6%) and tax) even without having to pay back the principal on the loan in the latter! Paying down early also reduces interest rate fluctuations effect on ability to repay.

Anyone with excel to hand fancy crunching the numbers?

In short, I think that the more disciplined you are the better it is to pay down and the earlier you do so the greater the advantages I outline above. Needless to say it is what I am doing.

This ignores using IO/not paying down as a gearing play to acquire assets which may be income generating (a la BTL). That is a different question to that of an individual with one home.

Edited June 4, 2007 by Tempest

[Warwick]

It depends on your attitude to risk.

However, in the UK, there is no tax relief for mortgage interest to buy one's home. So, for a Higher Rate (40%) taxpayer, paying down a mortgage with an interest rate of 7.0% p.a. is the equivalent of a guaranteed yield of 11.7% p.a.. Probably a no-brainer for most people.

[redwing]

Like most either/or questions the answer probably lies somewhere in the middle.

You'd be a fool to put all your savings into paying off you mortgage. I reckon anyone in a position to save should make sure they have about 6 months living expenses saved as a safety net.

Likewise, if you have very healthy savings, then it would make sense to use some of it to pay off the mortgage. Mostly, to do with taxation as mentioned in the above post.

So, it's not one or the other. It's about getting a balance.

[Pilgrim]

Like most either/or questions the answer probably lies somewhere in the middle.

You'd be a fool to put all your savings into paying off you mortgage. I reckon anyone in a position to save should make sure they have about 6 months living expenses saved as a safety net.

Likewise, if you have very healthy savings, then it would make sense to use some of it to pay off the mortgage. Mostly, to do with taxation as mentioned in the above post.

So, it's not one or the other. It's about getting a balance.

Exactly, a balance. 6 months living expenses- good point. Also that sum will obviously be a lot less with a smaller mortgage.

[DrBob]

You could save six months' salary, but alternatively you could get a mortgage which allows both underpayments and overpayments. Overpay as much as you can early on, then you can always draw on that capital later by underpaying.

Anything to reduce those compound interest costs, and to avoid paying tax on savings interest!

[Guest happy?]

You could save six months' salary, but alternatively you could get a mortgage which allows both underpayments and overpayments. Overpay as much as you can early on, then you can always draw on that capital later by underpaying.

Anything to reduce those compound interest costs, and to avoid paying tax on savings interest!

Sound advice. For most people, mortgages are the cheapest way to borrow money. Paying down money on a mortgage at 5-7% and then having to borrow at 15-25% for a car loan (because there's nothing left in the kitty) clearly makes no sense - yet this seems to be a really popular pastime nowadays. Worse, large numbers of people get suckered into 'homeowner loans' without ever understanding to whose advantage security works.

[Wad]

A serious question that people in the Uk have bene mislead over for years. Unfortunatley, paying off your debts does not generate sales commissions for financial advisors.

For the vast majority of people who have no skill or time to invest in the stockmarket - by far the best thing they can do is pay off their credit card debts, pay off other secured loans, then pay off their mortgage. For them, investing is a waste of time - the fees that will be paid to financial advisors and the fact that equity funds typically underperform means that they are taking risk for little or no reward. Borrowing at the same time as investing in equity funds is just leverging that risk for little or no return.

Edited June 4, 2007 by Wad

[harvipark]

As long as your investments are yielding more than the lending rate then you are better off with an IO mortgage and will be compounding the gains over 25 years. With a bit of experience and having a diversified portfolio of funds and shares then it should be possible to easily beat the lending rate if it's not too high

This is the approach I am taking at the moment. I have a fix till 2011 at 5.3% on interest only. The principle is invested in my portfolio which has returned 21.5% over the last 12 months

If I can maintain these returns on my portfolio, then the choice is a "no brainer"

[HPC Convert]

" There's a huge discussion happening both on Lifehacker and Get Rich Slowly regarding the pros and cons of paying off a mortgage early. Contrary to my own assumptions, the numbers (assuming current interest rates around 6%) seem to strongly encourage investing your money instead of paying toward your mortgage's principal.

On the one hand, you get a guaranteed outcome with paying down your mortgage. On the other, a conservative rate of return on an index fund should have no problem beating a 6% rate over the next 30 years. With the variability in people's risk-comfortability, there is no right answer here, but it's informative to hear the personal finance hackers weigh in with their opinions.

Are there any economists in the room that can explain how it's currently cheaper to borrow money and invest it elsewhere rather than to pay off debts? Why would a mortgage company ever lend money in this scenario?

Ask the Readers: Is It Better to Invest or to Prepay a Mortgage? - Link

Pay off your mortgage more quickly to save money - Link

DIY Mortgage Acceleration - Link "

Source: Hackzine

For many its not a simple investment decision - you have to weigh in risk of not being able to pay the mortgage. Take for example someone with a £200k mortgage - they could spend every penny overpaying it, something happens which means they lose their job and hey presto they get reposessed. Alternatively they could keep the mortgage and save the cash and have a cushion against unforseen drops in income. I guess the best spot to be in is where you have a good cash buffer and can overpay.

[SHERWICK]

Read a book called "Liar's Poker" to find out why, if you have a great rate for the term of the mortgage, it is always better to invest rather than pay your mortgage off early (providing you can get a better rate of return in a safe investment, e.g. a GILT).

Of course, due to emotional reaons, people, who could get a better rate of return, actually prefer to pay off the mortgage early - this is how the guy in Liar's Poker made money!

[evictee]

What people forget in comparing IO mortgages (allowing you invest you principal elsewhere) and paying down principal as fast as possible is that if you pay down your mortgage in say 10 years rather than 25 you then you have (assuming the same cashflows/income for the period) the ability to invest debt free for 15 yrs...I would need to run it through excel but I am not convinced the usual arguments in favour of not paying down early tell the whole story.

Over 25 yrs you compound your investment returns on the capital you invest which you would otherwise pay down but you always have the debt to pay down at the end so that has to be deducted from the overall total return.

If you pay down over 10 years you have no debt but have 15 yrs of cashflow to invest debt free. My instict tells me that 15 years of compound returns of, say, 10% pa after tax is better than 25yrs of returns of 4% after tax and interest (ie the delta between the gross return on investment and the debt interest cost (say 5-6%) and tax) even without having to pay back the principal on the loan in the latter! Paying down early also reduces interest rate fluctuations effect on ability to repay.

Anyone with excel to hand fancy crunching the numbers?

What are you talking about? There's nothing you need Excel for. All you need to know in deciding whether to use any given sum of money to pay off the mortgage or invest elsewhere is whether the expected return on your investment after tax is greater than your mortgage interest rate, that's all there is to it. The timescales you mention are completely irrelevant. Why are you seeking to obfuscate the maths? Are you in financial services?

[time]

What are you talking about? There's nothing you need Excel for. All you need to know in deciding whether to use any given sum of money to pay off the mortgage or invest elsewhere is whether the expected return on your investment after tax is greater than your mortgage interest rate, that's all there is to it. The timescales you mention are completely irrelevant. Why are you seeking to obfuscate the maths? Are you in financial services?

I agree with evictee on this one. Why do you need Excel again ?

[misfit]

It depends on your attitude to risk.

I completely agree with this statement which was why at the end of my last mortgage term I was left with a few K spare but instead of paying it off my mortgage as my rate is less than 5% until 2010 I entered this into my personal pension which should yield more than 5% in the long term.

As long as one is confident in terms of future employment then this is the route I advocate.

I therefore plan to keep 6/7 months of cash in the bank via a cash ISA and all other monies either go towards my pension or my monthly mortgage payments.

[Son of Taeper]

Is It Better To Invest Or Pay Off Your Mortgage Early?

I suppose it depends how good you are at investing. I had a mortgage and some investments (mainly shares) about 15 years ago. Property was on the up, my shares were on the up, I knew it couldnt last, so I cashed in and paid the mortgage off. I can't say the shares would have returned at the same rate as property since then but when we get the crash (which I'm sure we will) I'll still think it was the right decision.

[harvipark]

That's a great return and I suppose if you have a proven portfolio and the experience then it is ok to drop the principle payments alongside your regular investments and reap the same high yield and get the benefits of compounding which would very significant. Any money over and above is a bonus and that could potentially be HUGE!.

The stockmarkets are in a bull market but I am under no illusion that this will last and that 20%pa returns can be acheived every year. (but it wont be stopping me trying! )

You probably dont need that much investing experience to do this. For example, the FTSE 100 returned around 14% last year, and so investing in a simple index tracker would still have been better than paying down the mortgage. Or to be ultra cautious, if you have a low rate fix of around 5%, and assuming that we get another 2 rate hikes, depositing in a high interest savings account I reckon would pay about 6-7% (plus you have the benefit of being able to access the money should disaster strike)

It's got me thinking though - in this case high house prices may have been to your benefit if your portfolio can regularly return 20% plus over 25 years. If house prices were not in a bubble and your mortgage was HALF what it is now, would you be any better off in 25 years time?.... compounding larger amounts (the difference between your potfolio yield and lending rate) over 25 years would mean the overpaid principle would be a many times larger after 25 years despite the much higher price paid for the house.

Not sure I know what you mean by this.

The mortgage was taken out in '94 for 45k, on interest only with endowments to pay off the priciple. Endowments were later cashed in and proceeds added to my portfolio

I have never paid off any of the principle and so the orginal amount of 45k is still due. The fact that house prices have gone ballistic in the meantime doesnt make an ounce of difference to the mortgage (unless you go on a MEWing frenzy for that must have X5!)

[winkie]

It would be nice to have 1/3 mortgage, 1/3 cash or preferably tax free cash savings, and 1/3 other investments such as stocks & shares, managed funds, nat savings or anything else that you have researched well and review regularly.

[harvipark]

It would be nice to have 1/3 mortgage, 1/3 cash or preferably tax free cash savings, and 1/3 other investments such as stocks & shares, managed funds, nat savings or anything else that you have researched well and review regularly.

Yes I agree. That would spread the risk should one of your preferred payment methods underperform

I personally prefer IO mortgages as it gives you more flexibility to decide how to pay the mortgage. Providing that IO mortgages are not used to borrow excessive amounts (which is what we are seeing today), then they are by far the best option (IMHO)

[winkie]

Yes I agree. That would spread the risk should one of your preferred payment methods underperform

I personally prefer IO mortgages as it gives you more flexibility to decide how to pay the mortgage. Providing that IO mortgages are not used to borrow excessive amounts (which is what we are seeing today), then they are by far the best option (IMHO)

Nothing wrong with interest only, if you are puting away at least the equivalent of what a repayment mortgage would be into your choice of a repayment vehicle. When your assets exceed your liabilities you are in effect mortgage free.

[harvipark]

What I was trying to get at, is that because house prices are high you would be making even bigger gains when your potfolio yield exceeded your bank lending rate for a £200k loan than you would if you had a £100k loan. With the effects of compounding on growth and the the effects of inflation in reducing the real value of the original loan in 25 years time, you could actually be better off buying the overpriced home now since the compounded gains would be much much larger.

It's a theory but would have to be proved using an Excel spreadsheet with some assumptions, ie. that the portfolio yield beat the bank lending rate by an average of X% over the 25 year term.

Of course I might just be talking b***ocks!

Yes I understand your point now but not sure I agree that that would be the best approach

Say for example you bought a house at 200k now. The payments made to your portfolio would be more than for a 100k purchase, but the danger is that if we are at the point of HPC, the decining value of the house will wipe out the gains made from investing in your portfolio. Also for a 100k house, the payments would be lower, so argueably, you could afford to contribute even more to your portfolio and benefit further from the better returns.

The way I see things is to break down each asset class and look at their expected returns/costs in in the near future. i.e.

Stockmarket 10-15% pa (fairly conservative)

Cash 6-10% pa (assuming interest rates continue to rise)

Property -10% pa (assuming we get the HPC)

Cost of mortgage 5.3% (until 2011)

For me, I cannot see any point in paying off the mortgage until the fix runs out as better returns are available elsewhere

Zoom forward to 2011 and it may look like this.....

Stockmarket -10% pa (move to cash or pay down mortgage)

Cash 10-12% pa

Property +3% pa (time to buy a house!..wahay!)

Cost of mortgage 12% (switch to repayment mortgage)

Who knows how things will turn out, but I see lower house prices, higher inflation and interest rates. I am just watching to see how things unfold

<edit> Apologies for the crap formatting

Edited June 5, 2007 by harvipark