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The last few Blogs have been focused on informing you on how you can access money from your Pensions, both Personal Pensions and Employer Company Pension Schemes, when that time comes.
For many of us I am conscious that the single biggest financial mountain to climb is one's mortgage. This can often lead, and I'm sure has done for some of you, to the question;
"Should I invest and save for the future, or focus on getting rid of my mortgage."
You can access the full show notes below, or jump in here:
I had the very same question put to me by a friend recently, he had a large lump sum of money which he had been managing for several years, rolling it over in various accounts, the interest rates constantly falling. He was considering throwing it at the mortgage, bring down the term left. What should he do...................................................What would you do?
Listeners to the Informed Decisions Podcast will recall Episode 8 (listen here) where we saw the massive impact a relatively small change in mortgage repayment can have on the term of one's mortgage. This Episode was hugely popular and the Pro's below outline why.
For completeness sake lets look at some Pro's and Con's of 'Clearing my Mortgage' instead of 'Investing my Money For the Future'
Clearing My Mortgage ? The Pros?(not exhaustive)
- Guaranteed Return on Investment: If you invest your money in clearing your mortgage you are guaranteeing your return on that investment, there is no danger that the mortgage could come back in future if markets got rocky! You achieve the immediate return of eliminated interest expense.
- Save on Interest Costs: As above it can save you tens of thousands in interest, which you would have been paying had you not cleared the mortgage.
- Peace of Mind: This is probably the single most obvious and rewarding one, the fact we now own our home can be a great source of peace of mind for the future, irrespective of what might happen your income.
- Reduced Cost: By removing the mortgage payment from your monthly outgoings you are reducing your costs, and for some it's big-time!
- No Need for Mortgage Protection Insurance: If you have no mortgage loan the lender does not need you to have Life Cover on that loan in order to repay it if you die, another cost reduction.
- Satisfaction: Many of us will remember forever the people we meet who tell us they have 'no mortgage'. It's akin to meeting a celebrity, it is that highly revered! Not necessarily justifiably so, yet it is a primal instinct in us to own the roof over our heads. Achieving that can result in a great sense of satisfaction.
Clearing My Mortgage ? The Cons?(exhausting!)
So there are lots of really great 'Pros', but before we write the cheque lets look at the full picture, this side is somewhat technical, so brace yourself!
- Low Return on Investment: If you invest your money into clearing your mortgage you could be signing up for comparatively low returns on that money. Why? A mortgage is likely the cheapest money you will ever borrow. The rate on majority of mortgages in existence today is in the 3-4% region. You are essentially signing up to that rate with the investment you are making to the loan. Consider for 1 second that in the 1980's when our parents were in the same position the rates were upwards of 20%! There would be no debate in those circumstances!
- Savings Are in Lower Future Value: All the monetary Pro's were in future savings, meaning they need to be adjusted for inflation. This has a large impact. For example, let's assume you pay off your mortgage in 25 years instead of 30. Using this Investopedia present value calculator, you'll see that ?1,000 in 25 years time is only worth ?423 in today's terms at a 4% inflation rate. In other words, you have to discount all savings by inflation because the payments you avoid will be in this lower future value. Takes the sheen off slightly?
- All Eggs in One Basket: Investing all your funds into clearing your mortgage (property) flies in the face of logical and informed Investing.
- Make Money by Owing: If you have a Tracker Mortgage or indeed a very good deal on a fixed rate it could in time be lower than the prevailing inflation rate. Inflation rate is currently hovering around the 0% but if it were to rise you could literally be earning by borrowing, in real terms (after inflation), even though you're paying interest every month. If your mortgage rate was 1.5% and inflation was 1.6% you essentially make more by owing than by owning. If you clear your mortgage you give away that potential financial advantage.
As you have deduced by now, the 'Pros' to clearing your mortgage are fairly obvious and appetising to most of us, however the 'Cons' are somewhat more murky and financially complex, reliant on long term inflation effects and discounted present and future values!
If you sought advice on the matter many Financial Advisers may will quickly highlight to you the long-term historical returns for a given investment product of 6-8% per annum. When this is compared to mortgage rates of 3-4% it seems there is no debate. Common sense would also suggest the following:
Investment returns via such a vehicle are highly variable, they can have periods of double digit growth which far outstrip mortgage rates, and indeed periods of double digit downside (losses) where even paltry mortgage interest rates represent a far superior return on your investment.
As we all know the future is not the past and returns will vary, but mortgage interest saved is a bird in the hand. It is important to acknowledge however that suitably chosen investment funds have more often than not outperformed mortgage interest rates over the term of an average mortgage (20-30 years).
While the mathematics may well point to the fact that investing for the future should provide the investor a greater return in the long term than clearing the mortgage it really is a personal decision. This decision will usually be driven by one's motivations and by how they want to feel, and that to me is proper, provided it is an informed decision.
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Paddy Delaney. QFA, RPA