Sunday, 20 February 2011

Pay off Mortgage Early or Invest More?

Should I continue to pay normal monthly mortgage payments or pay off my mortgage early?

The facts:
£114,000 remaining over 22 years
1.49% interest rate (at the moment, tracker rate of 0.89% above base rate)
£600 / month spare cash available.
So repayments are £507 per month at the moment.

I don't wish to keep paying a mortgage for the next 22 years so some form of accelerated payments need to begin.

So how much should I overpay? Or is it more sensible to keep payments to the minimum and invest the remaining money into ISAs?

Some maths is required:

Standard Payments
£507 / month over 22 years
£425 / month into a cash ISA (filling the ISA allowance of £5,100 / year) - currently paying 2% pa paid monthly
£175 / month into my Interactive Investor Stocks and Shares ISA invested in a range of stocks. Yield on the lot is currently about 4% pa
Standard Payments will end up with a purchased home and debt free in 22 years plus £141,030.00 in the cash ISA and £74,797 in the stocks and shares ISA. This ignores any possible capital growth from the shares.
Net worth of £215,827 plus the value of the home.

Accelerated Payments
£507/month plus £600 / month over payments. When the home is paid off early all remaining sums go into ISAs as above. There will be some spare capacity as the current ISA limit is £10,200 per year. Lets pretend for argument sake that the remaining £3,000 is put in an ordinary bank account paying 2% pa but subject to tax at the higher UK rate (40%).
This method will yield a home debt free in 9 years and 3 months. Leaving 12 years and 9 months of income generating with £1100 / month to invest. This will give me £74,121 in the cash ISA, £86,034 in the iii Stock ISA and £41,350 in the standard bank account.
Net worth of £201,505 plus the value of the home.

The valuations are extremely close and this has a lot to do with the low interest rate world we live in at the moment. What to do depends a lot on how you value debt and the worth you place in home ownership. The faster home repayments will mean many more years of a debt free life. Should the worst happen and money does not continue to flow in, the lack of home repayments mean that I can live on a much reduced income if necessary. Confirming my view of the worth of overpayments is the low interest the mortgage current sits on. This can't last forever and my payments will increase reducing the amount of spare money I have anyway. The faster I reduce the overall debt the more freedom I will have later in life to do what I wish.

And yet, I have a nagging doubt about this. With inflation running away at a mad pace, the debt of my home is likely to feel like nothing in 10 years and payments are likely to feel a lot easier allowing me to choose to pay off bigger sums. And with just a couple of % points increase in the interest rate of my cash ISA it would yield £180,038 over 22 years at 4%.

Anyone else got any ideas about what to do?