Pay off your mortgage or invest? This calculator will help you decide

When interest rates are high or rising, many private investors wonder: “Should I pay off my mortgage or invest?”

Persistently low interest rates have made larger mortgages affordable.

House prices have soared with lower borrowing costs.

At the same time, the returns from sensible passive investment have trounced the savings from paying down your mortgage.

So, in hindsight, investing in the markets has been more profitable over the past decade than paying off your mortgage early.

Paying off a mortgage will always be worth considering. Debt can be deadly. Owning your home outright is financially liberating.

Very few people who pay off their mortgage regret it.

But this is Monevator. We like to kick things around – and sometimes to do things differently.

Pay off the mortgage or invest?

Borrowing to invest is typically a bad idea.

Returns from investing are uncertain and volatile.

Debt – and the cost of debt – is a certain liability.

Mortgage debt is relatively cheap and manageable, however. I believe it’s the only way most people should consider borrowing to invest.

A mortgage is money rented from a bank. Typically we use that money to buy a property. But if we delay repaying the mortgage to build an investment portfolio, we’re effectively using the mortgage to invest.

In this scenario our home stays mortgaged for longer, like an investment property. It’s almost as if you’re a landlord – someone who borrows money from a bank on your behalf – except you’re your own tenant.

If you trust yourself to meet your mortgage payments whilst also saving into an investment portfolio for the next 25 years, then with average investing luck you’ll probably end up better off investing versus repaying.

However there’s a lot to think about when deciding whether to pay off the mortgage or invest. The decision is as much about risk as any reward.

Come with us via the scenic route! We’ll tour the landscape, and wind up at a calculator enabling you to further explore the options.

First things first: Non-mortgage debt must go

Have you got credit card or store card debt or any personal loans? Get rid of that debt first.

Student loans may be an exception, as MoneySavingExpert explains. Think carefully before repaying any student loans.

The interest rates on credit cards and loans are much higher than on a mortgage. Credit cards typically charge 20% or more.

That rate is double the average returns you should dream of achieving in the stock market.

The risk/reward equation of trying to grow your money faster than you’re losing out due to expensive debt is terrible.

Running a credit card debt at 20% while investing in shares is like rowing across the channel on a raft made from chicken wire.

At 5% or even 6% – a very cheap personal loan – the maths might work.

At 20% or more it definitely doesn’t.

If your already-optimistic 10% returns are sapped by taxes and costs, then even loan rates of 7% or 8% aren’t worth thinking about.

And many people would expect much lower investment returns of 4 to 5%.

In short – unless you’re the new Warren Buffett – only mortgage debt is cheap enough, given the risks, costs, and likely returns from investing.

What about margin? Some gung-ho sophisticated investors use margin debt from a broker to fund property. The risks are magnified because unlike with a mortgage, margin debt is marked-to-market. This means that if stocks fall, you must stump up more assets or else repay the debt. The strategy can work, but it’s beyond the scope of this article. I suggest 99.9% of readers push away thoughts of margin debt. With a 20-foot barge pole.

Pay off your mortgage: a good, safe option

If you can pay off your mortgage early, you’ll be in a great place financially.

There is no law of smart investing that says you should do anything other than pay off your mortgage first.

Many people would kill to be mortgage-free.

Crucial point alert Repaying a mortgage is a form of saving. If you pay £10,000 off your mortgage with a cash windfall, it has the same immediate impact on your net worth as putting it into a savings account. When you pay down the debt, your (negative) mortgage balance is made £10,000 less negative. When you save the money, your (positive) cash balance is £10,000 higher. Your net worth – assets minus liabilities – is the same in both cases.

Repaying your mortgage is usually a better option than saving in cash.

Interest rates on cash are on the floor – around 1% at best. Most mortgages charge a lot more. You’ll achieve a higher return by paying off your mortgage and avoiding interest, compared to earning interest on cash.

In fact depending on your personal tax situation and where you hold your savings, the benefits of paying down your mortgage can be even bigger.

At a certain point, interest income from cash outside of an ISA is taxed.

In contrast, paying down your mortgage delivers a tax-free return via those future interest payments you’ll never need to pay.

You should have an emergency fund before investing or making over-payments on your mortgage. Just in case you need cash in a hurry.

If you have reason to hold even more cash at the same time as a mortgage (maybe your income is uncertain) consider an offset mortgage.

Pay off your mortgage to get out of debt early

Paying off a mortgage early will slash the years you’ll live in debt.

Imagine you borrow £250,000 at 2% over 25 years.

According to the Monevator mortgage calculator, you’d pay £1,122 a month, give or take a Mars Bar.

Our calculator also handles over-payments. Let’s say you can bring your monthly payment up to £1,500 by overpaying £378 a month.

You’ll save £29,049 and cut seven years off the life of your mortgage.

Here’s a graph to see the difference. The red line shows how overpaying accelerates your mortgage repayment schedule:

I’m ignoring a few things here, especially inflation and the time value of money.

If you go shopping with £378 today it’ll buy more than in 25 years time.

But that would be true too if you kept that £378 in cash or invested in a fund. So we can ignore inflation when comparing these options.

A few more reasons to murder your mortgage

Paying off a mortgage early is a great aspiration, and for good reason.

Being debt-free is mentally liberating. Pay off your mortgage early and you experience that benefit sooner and enjoy it for longer.

Other pros of paying off your mortgage include:

It’s a guaranteed return. You’ll earn whatever interest you save, unlike the variable and unknown returns from the stock market.

It reduces big picture risk. The smaller your mortgage, the less chance a financial upset like unemployment, illness, or divorce sending your finances spiraling out of control.

It’s simple. There’s no fussing with funds or shares or anything else. Just throw any spare money at your mortgage!

You should be able to remortgage to a cheaper rate when you’ve built up more equity in your home. That will save even more money.

You may be happier investing in volatile shares when you have no mortgage. And you should have more spare cash to do so.

Selling your home is tax-free. If you decide to sell up and go traveling, say, you’re not taxed on any gains you make on realizing your own home investment. If you’d instead invested spare cash outside of an ISA or a SIPP, you might. True, the ISA and pension contribution limits are generous for most people – £60,000 totaled in a year – so that usually won’t matter. But it may be best to put big windfalls like bonuses or inheritances into paying off your mortgage.

You can be too clever in life. Paying off the mortgage is hard to beat. I’ve never met anyone – aside from online commentators – who regretted it.

Now, I personally run an interest-only mortgage in pursuit of higher returns. But I would never mock anyone who wanted to clear their debt ASAP.

For the average wage slave, being mortgage-free is one step to nirvana.

Invest instead: risks and rewards

There’s only one reason to invest instead of paying down your mortgage.

You hope investing will leave you richer!

The long-term average return from developed world stock markets depends on how you measure it. But it’s in the ballpark of 7-10% a year.1

That compares well to today’s competitive mortgage rates of 1-3%.

The catch is you can’t get a cheap mortgage to buy shares.

However by running a 2% mortgage and investing your spare cash into the market instead of paying off your mortgage, you might earn 8-10% over the long-term from your portfolio, and get to pocket the difference.

At the least your portfolio needs to deliver higher returns2 than your mortgage rate for investing to be profitable.

But considering the risks of investing, you’ll want to do markedly better than that for the uncertainty to be worth it.

Aiming for a high return means investing in riskier assets – specifically shares.

And shares are very volatile. Your portfolio’s value will fluctuate. You could suffer a deep bear market where you’re down 50%. Over a typical 25-year mortgage term, you’ll likely see a couple of very big declines.

Worst of all, there’s no guarantee that even a globally diversified portfolio will do better than paying off your mortgage. Only historical precedent.

It’s all very different to paying down a mortgage for a certain return.

Remember: house prices are volatile, but your mortgage balance isn’t. It’s irrelevant if house prices fluctuate when it comes to the returns you see from paying off the mortgage or investing. You’ve already locked-in the purchase price of your home. Paying off the associated mortgage delivers a known return. Investing earns an uncertain one. House prices fluctuate regardless.

How to invest instead of repaying your mortgage

Regularly investing into index funds will be the best approach for most.

Investing globally diversifies your money across many markets. That way you’re not exposed to any one country, sector, or region.

Index funds get you the market return at the cheapest cost.

We think a global tracker fund is the only equities fund most people need.

If you wanted to try for higher returns, you could tilt your passive portfolio towards value shares and small caps, especially early on when you’ve more time to make good any disappointments.

There’s no guarantees you’ll not do worse for trying to do better, though.

If you’re a naughty active investor, you’ll have your own ideas about how to invest to beat paying off your mortgage.

Just remember that in some circumstances the ownership of your home could be at stake. This should influence the risks you take.

Interesting choice

Suppose you have an interest-only mortgage. If you can’t repay it at the end of the term because your bets on Bored Ape NFTs or blue-sky biotechs blew up, you’ll probably have to sell your home to repay the bank. Invest wisely!

More commonly you’ll have a repayment mortgage, whether you’re an active or passive investor.

Here it’s your potential over-payments that you’re instead directing into investing. You’ll still pay off your mortgage over 25 or 30 years with your regular monthly mortgage repayments.

That’s much less risky than an interest-only mortgage.

True, if your investing does well you’ll make less money with a repayment mortgage than if you’d gone interest-only. But it may still have been worth it to reduce risk. You’re already taking on risk by investing in shares instead of clearing your mortgage, remember.

What about other assets – like bonds? They’re usually part of a passive portfolio, right?

The trouble is that as you add safer assets to counter the volatility of your equities, you also reduce expected returns.

And that is pertinent because you’re pitting investing in the markets against the certain return you could otherwise get by repaying your mortgage.

Is it sensible to put 40% of your portfolio into a bond ETF returning 1%, when you could use that money pay off mortgage debt costing 2%?

Arguably not – except there’s more to diversification then that.

Up to a point, adding safer government bonds to an equity portfolio will reduce risk (volatility) more than it reduces returns.

A smoother ride can make it easier to stick to your investing plans.

Still, if you’re going to invest instead of taking the safer return earned by repaying your mortgage, you’ll probably want to invest pretty aggressively.

Equities should probably comprise at least 70% of your portfolio for you to have a good shot of making all the risk and uncertainty worthwhile.

On which note…

You might regret investing, if you’re unlucky

Know that there’s no guarantee you’ll do better by investing.

Sure, historical stock market returns suggest that over a mortgage term of 25 to 30 years you’d be unlucky to lose out. That’s assuming you invest regularly, mostly in equities, and stick with it through the tough times.

But the past is no guarantee of the future.

Also, just like retirees you face sequence of returns risk, especially with an interest-only mortgage – because what if the stock market crashes a year before your debt is due?

Luckily you have some flexibility over a long mortgage term.

For example, if your portfolio shoots the lights out for a decade, you might change gears and start paying off your mortgage instead. (As opposed to pushing your luck into a stock market bubble.)

You could even sell down your bulging portfolio to start repaying your mortgage early. The best of both worlds!

Avoid early repayment charges. Take note of your mortgage’s fine print. Most lenders only allow a portion of the balance or initial advance to be repaid each year without penalty – for example 20%. You can still sell down your portfolio by more than this if that seems appropriate. Just keep the proceeds in cash, and pay off your mortgage as its terms best allow.

Alternatively, you could simply use new cash from your salary to overpay your mortgage. Your existing portfolio could then be left to (hopefully) keep growing.

Watch the direction of interest rates! What made sense with mortgage rates at 2% might look very different if you must remortgage at 5%.

Use tax shelters

You’ll certainly want to invest in a tax shelter to keep all your returns. Either an ISA or a SIPP3.

There’s a snag with relying on a SIPP though, especially if you have an interest-only mortgage. Access to pension cash is restricted by age. What if you find you want (or need) to repay the mortgage sooner than you’d expected to?

In that case you’d have to wait until you’re allowed to withdraw money from the SIPP – well into your mid-50s. You might then use your pension’s tax-free lump sum facility to pay off your mortgage.

Of course, most people have a mortgage whilst earning a salary and paying into a pension – for their whole working life.

Like this they’re actually funding their pension via that mortgage debt, as we’ve discussed above.

But few will ever think of it that way – including some who of those who criticize articles like this!

As for ISAs, their tax-free status is such a boon we’ve suggested that opting not to repay a big debt – like a mortgage – or even taking out new debt might be worth it just to maximize your contributions. This way you can build up your future tax-free shelter capacity.

ISAs are accessible at any time. That could be crucial if your plans change.

Think carefully about how and where you divide your assets. If you go down this route you’ll probably want to use both ISAs and a pension.

More reasons to run a mortgage and invest

Investing in equities is for the long-term. But if you wait until you’ve paid off your mortgage before investing, you’ll have a shorter time horizon.

You need to get used to volatility in risky assets. Starting young helps.

There’s much more to the economy than house prices. Do you want all your eggs in the property basket while you pay off your mortgage?

For my part, for the past few years I’ve been running an interest-only mortgage while investing mostly in equities. I’ll probably keep doing this until either my mortgage rate rises substantially or I can’t find any markets worth investing in.

But investing like this will not be right for everyone – and it is not advice! Do your own research. Weigh up paying off your mortgage instead.

Mortgage repayment calculator/spreadsheet

To help you decide, we’ve got a calculator embedded into a Google spreadsheet that can help you calculate and visualize the potential returns.

(Thanks to Monevator reader ArnoldRimmer for the initial work here!)

Open the spreadsheet in a browser. Then make a copy of the sheet. You can now edit your copy to play with the numbers for yourself.

If you share the sheet with friends or family we’d love it if you send them the original sheet please. For starters it includes a link to this article, so they can read all the important background information.

The six yellow cells are the ones to edit to try out different outcomes.

The spreadsheet runs the numbers on four scenarios:

Repayment mortgage. No extra savings – you spend your spare cash.
Repayment mortgage with mortgage over-payment.
Repayment mortgage, but investing instead of making over-payments.
Interest-only mortgage. Investing instead of any mortgage payments.

You input the mortgage size and term, interest rates, amount of cash directed to either over-payments or investing, and your expected return.

The table below plays out those numbers over 30 years. The first four columns shows your growing net worth from repaying the mortgage and/or investing. The final two columns shows your portfolio growth, without netting off the mortgage balance.

The cells flip to green when your net worth becomes positive and you repay your mortgage – or could do so from investments.

Real-life returns are not smooth like in a spreadsheet. Calculations like this can only give an indication of how an annual return would compound over time. In reality annual returns would be lumpy, and in some years they will be negative. Perhaps very negative. Your investment portfolio will go down, maybe by a lot! Do not expect an easy ride.

The spreadsheet is not super sophisticated. The idea is to let you explore what’s possible – not to map the future, which is anyway unknowable.

For example, you will see that a £250,000 mortgage charging 2% over 25 years with £250 a month in either over-payments or investing delivers:

You can see that investing whilst running the mortgage can leave you much better off (Scenarios 3 and 4).

But simply over-paying your mortgage is financially good, too (Scenario 2).

And in the first scenario you had £250 a month extra to spend on fun, of course. The extra gains in the other three scenarios didn’t come for free.

Perhaps you object to these interest rate or investment return examples? That’s fine and the whole point of making this editable spreadsheet.

Create a copy and play with figures that you think are realistic.

Remember that real-life investing is volatile and uncertain, whatever numbers you use. If it wasn’t then this strategy would be a no-brainer. It’s not, because the potential downside is real, especially over shorter periods.

Interest rates will change over time too, of course.

The spreadsheet is a guide to what might play out over 25-30 years, looking back in a rear-view mirror. You mileage will definitely vary.

So… pay off the mortgage or invest?

The decade or so after the financial crisis was very kind to investors. Most markets did well, especially the heavyweight US.

At the same time – and not coincidentally – interest rates stayed low.

In hindsight it was a great time to invest rather than pay down a mortgage.

I’d even argue this wasn’t completely unforeseeable.

After the March 2009 rout, the odds of superior returns – greater than 10% – from shares over the medium-term looked pretty good.

I even wrote that year that a decade of 20% a year returns seemed possible, given the huge crash we’d just seen.

If you invested the money you saved in lower mortgage payments in those gloomy times, you deserve applause – or maybe your own hedge fund!

People had been scarred off shares, and investing in general. They’d been through a once-a-generation financial crisis.

But were the record numbers paying off their mortgages chumps?

I don’t think so.

As I said at the start, paying off your mortgage is never a bad idea. There are financial benefits, and it reduces risk. There are non-financial wins, too.

Remember that our spreadsheet only shows smooth growth over the years.

In reality it would be a wild ride of unpredictable highs and lows.

Markets today look much more expensive. Rates are rising. It does not seem such a propitious time to fund an investment portfolio via a mortgage.

However for disciplined investors with broad shoulders and girded loins, running a mortgage while investing will probably still win in the long run.

Do your research, think about risk tolerance, and make your own mind up.

In nominal terms, which is also how your mortgage rate is calculated.After taxes and fees.Self-Invested Personal Pension

The post Pay off your mortgage or invest? This calculator will help you decide appeared first on Monevator.

It’s the age old question – pay off the mortgage or invest? And there’s no simple answer, which is my excuse for writing an exhaustive post on the subject.
The post Pay off your mortgage or invest? This calculator will help you decide appeared first on Monevator.

More Posts