[Closed] Mortgage Over payment which is best?

My understanding was that reducing the term was always better. If your monthly payments are reduced, the mortgage provider will make more out of you in the long term, after all, isn't it just handing you back some or all of the extra money you're investing to reduce the debt?

IANAIFA DYOR etc....

I've been working on the basis of keeping the monthly repayment amount the same so I think I've been asking to reduce the capital balance instead of the term. Make doubly sure your provider knows what each of your overpayments is intended for. I've had instances where by paying an amount similar to my monthly amount- the provider assumed it was reducing the term.

Stick it into your pension instead, tax efficient.

Reducing the term will mean you pay less over the life of the mortgage. Is there a maximum overpayment amount, mine is 10% p.a. but oddly that only counts for single payments more that 3 times my monthly payment, so if I had the money I could pay off £2900 every day until there was a balance of £1, then leave it until the fixed rate period ends, mind you Barclays are staggeringly useless so I'm sure they'd screw it up somehow.

What edaward said. If it's about the money then it's better invested elsewhere. Either top up the pension or stocks and shares ISA. Much better return over that period. If it's about the principle of paying off the mortgage (which will be a nice feeling even if it's not the most money efficient) then surely shortening the term is the best thing to do

Aren't the two the same? If you pay off the capital directly with your overpayment then your next months repayment will be less interest as a proportion and more capital repayment therefore your term will automatically reduce assuming you keep your monthly payments the same. If you overpay the same amount every month then the term reduction, and therefore saving in interest, would be the same as if you opted for the reduced the term option wouldn't it?

I don't agree with the idea that you're better off investing it unless you have a very small mortgage. You might get a better headline interest rate in an ISA, but your mortgage rate is applied to a much larger capital so your actual interest payments in £'s will be much higher than the pittance you'd earn in interest via an ISA on £110 a month. In most cases you're always better off clearing debt before investing. You just have to do the sums to see which option is best for you and the kind of numbers you're talking about...also there is the risk of interest rates increasing so the lower you can get your mortgage now while they're virtually interest free the better off you'll be when mortgage rates start to increase.

I don’t agree with the idea that you’re better off investing it unless you have a very small mortgage. You might get a better headline interest rate in an ISA, but your mortgage rate is applied to a much larger capital so your actual interest payments in £’s will be much higher than the pittance you’d earn in interest via an ISA on £110 a month. In most cases you’re always better off clearing debt before investing.

Nope, both are the same if it's the same interest rate. The money saved by overpaying an amount / month between now and the end of the mortgage is the same as putting that same amount / month into savings at the same interest rate.

The difference is the mortgage is at 2% and the pension is likely a lot better and benefits by being before income tax. So assuming you didn't need access to the cash between repaying the mortgage and retiring then the pension would be the option that returned the most financially.

It's an odd case though as generally building societies make money on the differential between what they charge borrowers vs what they give savers. As banks are subject to the same market forces their rates are similar.

Short answer: reduce the term.

Long answer: "paying off capital" vs "reduce the term" makes the options sounds more different than they really are. Your loan has a balance, and any payment you make reduces that balance. You get charged interest based on your outstanding balance. The question is really "do you want us to recalculate your monthly payments to keep the term the same or keep your payments the same so the loan is paid off early?"

It sounds like you're comfortable paying X + £110 (where X is your currently monthly payment), so you want to carry on doing that so that the loan gets paid off early and you end up paying less overall.

If you choose "reduce payments" then you'll pay X + £110 in the first month, X + £110 less a little bit next month, then X + £110 less a little bit more, etc. so you're paying off less each month, your outstanding balance stays higher, so you're paying more interest.

On my mortgage, they only actually recalculate payments annually, but the principle is exactly the same.

I’d say to tell them to reduce the term.

If you make overpayments, you’re reducing the capital outstanding. The two options only differ in what happens next.

If you tell them to reduce the term what it really means is “keep my payments the same”. If you ask them to reduce the monthly payments they’ll do that in order to maintain the length of the mortgage. As said above it’ll depend on how often they recalculate as to what happens to the repayments was in that case.

As to overpayments VS pension, that’s harder. If you’re a higher rate taxpayer you would get a bigger contribution thanks to the 40% tax relief, and the growth is likely (but not guaranteed) to be more than the mortgage rate. But it’s a long term payoff: you may need to access that money sooner, or be glad to have paid off some capital if you want to move somewhere larger or if rates shot up. As a standard rate taxpayer the difference is less, but it could still be a good move.

Only you can judge if pension investment is best for you, and size of mortgage, term remaining, LTV, income, future plans, family etc all factor in.

I have kept the term the same. As the required monthly repayment comes down every year we keep the actual payment the same, so the overpayment goes up.
We will pay it off sooner but always have the option to go to a lower monthly payment, or have a buffer if rates increase, without renegotiating the term.

Thanks everyone. I'll get them to reduce the term. This is more of a priority at the moment than a pension. I can actually see the benefit with this unlike with a pension as thats just something that will happen in a few decades time, if I don't die first!

Very much a personal choice down to your own psychology/emotions/priorities etc, but in terms of economics alone, I spoke to two IFAs recently and both basically said beef up your pension and forget overpaying the mortgage. I liked the idea of overpaying on ours, but now I'm planning the pension route. Duller, but makes more sense for me.

It’s not bad advice to beef up your pension, but when it comes to an IFA it’s worth being aware that much of the time this advice is also going to earn them more, whereas paying off your mortgage does not. I try to do both where I can, am about to be paying 30% of my net salary into my pension now, together with overpaying the mortgage too. Although I recognise my pension is important I also cannot wait to be mortgage free!

This thread has made me nervous.   I was set on paying off my mortgage, thinking that the lucky-to-have six figure sum in my pension would provide a decent amount.   I got my illustration the other day - £6,700 a year after a retirement.

I'm a bit befuddled about the choice of not having a mortgage to pay when I retire, or having a mortgage but a slightly higher income from pension/annuity.

My IFA said there is no point stuffing it into to a pension as its too late to make much of a difference (I'm 45), I don't have enough to stuff into it (I'm not a hr tax payer), and I'd pay the tax on it when i retire. He described pensions as tax deferred not tax free.

His advice to me was pay off the house and cash it in when required as an income after retirement. Perhaps not the nicest thought that I'd have to sell the family home to retire, but I've not got a lot of options!

FWIW, I do also have a pension plan.

How is it too late at 45??? That sounds like terrible advice, unless you’re planning on a very early retirement. Also 25% of your pension pot is tax free, without using up your tax free allowance, so it’s still very much worthwhile, and plenty of time to build it up at age 45.
And yes you need a lot more than a 6 figure sum in your pension if you want it to be much use to you! ☹️

Couple of simple things to remeber.

1. Debt always costs more than you'll make on investments.
2. Your pension is likely to less per month than your wages, if you don't pay into a pension you'll pay 20% or 40% today in tax + NI. So yes it is tax deferred but also likely to be significantly reduced tax.
3. When you take your pension you'll pay tax on it, but only your invcome above your tax free allowance, in the majority of cases tax paid on the pension will be a lot less than tax paid today.
4. Extra money into your pension today means more returns into your pension pot.
5. Equity release from a property is not a good long term strategy for retirment and rarely ends well.
6. theboysneeds - your IFA sounds extremely dodgy.

Run the two scenarios though this.

https://www.moneysavingexpert.com/mortgages/mortgage-overpayment-calculator/

Pay off the capital and you will reduce your monthly payments.

Reduce the term and monthlies stay the same.

Do you need the extra money each month or will it just get fritzed away? You never know whats around the corner. I would pay off capital and save the difference in monthly. When savings are rebuilt then pay off a chunk more. But if it will just be fritzed away then reduce the term.

Mentally I was playing with the fact that instead of paying the mortgage down, paying the same amount of money into a pension assuming equal amounts of growth via equity or investment growth doesn't work.

So, for sake of argument I owe £150k on the mortgage with 12 years to go.  If I pay that into my pension instead for 12 years, I'd end up with another £6kpa at retirement - a total private pension payout of £12,700 per year.  However, as my mortgage is £1kpa, the mortgage payments per annum would wipe out my total private pension payments and I'd be living on state pension.

Yet, If I had paid my mortgage before retirement, I'd own a house, have £200k equity (at todays sales value) in my back pocket and I'd have a pension income of £6700pa over the state pension.

Unless I've missed something...?

if your total pension is going to be £350k without extra payments, and you add anextra £250k inputs (which has a £150k impact on your salary, assuming you're a 40% tax payer), you can withdraw 25% of it (£150k) tax free, pay off the mortgage with that, then end up with £450k left on your pension, £100k more than you would have had otherwise.

Oh wow thanks - my understanding was clearly incorrect.

So - sorry to be a simpleton - how does my tax contribution end up in the pension because the total contribution is being paid by my employer?

so am I receiving this tax relief via my PAYE?  Which changes the calculation, right?

If you’re talking about a workplace pension then you now contribute 5% of your salary up to a maximum which I can’t remember, and your employer contributes another 3%. Your contribution is taken out of your gross salary before tax so you don’t need tax relief on it.

Yes, it turns out that my company matches the 5% I pay in then adds that to the money deducted from my gross salary.

So, I have the choice of paying more into the pension, or more off the mortgage.  Surely then, it’s a matter of which grows more over time?

I would shove into pension. Expecting modest growth plus your tax break versus a currently cheap mortgage rate, it should do better.

Tax relief on pension contributions: does it help to think of it (rather than as 'extra' money) as money that never gets taken away by the tax man! It's yours anyway, just paying it into your pension right away means he doesn't take his bit from that.

Which makes a bigger difference if you pay high Tate since the bit he'd have taken is bigger!

Also, especially if work will match what you put in THEN DO THAT! Even as a standard rate payer, giving up your £110 into your pension straight from Your salary puts £137.50 into your pot, plus another £137.50 if you employer matches it.

£275!

Yes, it's taxed on the way out, but with £12500pa tax free it'll likely be taxed only a little!

However, in the usual stw way of giving conflicting advice, it looks like your looking at paying your mortgage after retirement? Can you do a little overpaying/term reducing to finish the mortgage before your expected retirement date? Makes the house an secure asset rather than a monthly bill, even if it makes less sense on the bottom line it might still be worth it.

If no "mortgage while retired" case then do the pension!

So to be clear:

I’m 47 and have a current plan to clear the mortgage by 57, using overpayments.

The question was based in the fact that those overpayments could instead be invested in my pension.  This might then mean instead paying off the mortgage by 62, but would double my pension investment by the time im 65

My company pays 10% of my salary into a HL portfolio for me, with 5% of that being my contribution deducted from my gross pay, then the other 5% matched by them.   I therefore assume i get tax relief via paye and that is why (when i looked at my HL account last night) i cant see tax relief being paid on my HL statement.

Therefore the bare bones for me (and i hope this mine field is helping others under standing) is a question of which choice do i pay into - mortgage or pension.

For me, owning a house at 57 with no mortgage opens a whole load of options in later life

a question of which choice do i pay into – mortgage or pension.

For me, owning a house at 57 with no mortgage opens a whole load of options in later life

In your situation the pension is by far the most financially sensible option but the money will be be tied up and you will still be paying the mortgage later in life. You may still have those 'mortgage free' options available to you as you know that extra wad of cash is coming in a few years time.

There is the also the middle ground option of a stocks and shares ISA. If it goes well it will accrue more than your mortgage cost so at 57 you can cash it in, pay off the mortgage and have a lump sum of cash. This is a gamble and requires the stock market to beat mortgage interest rates. They have done this comfortably recently but that doesn't mean that will carry on. Worth a punt IMO but it shouldn't be your only plan

"here is the also the middle ground option of a stocks and shares ISA. If it goes well it will accrue more than your mortgage cost so at 57 you can cash it in, pay off the mortgage and have a lump sum of cash. This is a gamble and requires the stock market to beat mortgage interest rates. They have done this comfortably recently but that doesn’t mean that will carry on. Worth a punt IMO but it shouldn’t be your only plan"

This is in effect the same as putting it into your pension, only you pension is tax deferred.

If the S&S ISA does not beat your mortgage inflation, your pension will not either. They are both effectively the same investment vehicles (assuming similar funds chosen to invest in) but with different tax wrappers.

Another thing the OP is worth considering, is what is your LTV just now, and what is the forcasted LTV at the end of your fixed rate? It can be worth overpaying to get you into the next level down LTV to get better interest rates at remortgage time.

Also the reddit group, UKpersonalfinance is a good source of information on this sorta thing.

This is in effect the same as putting it into your pension, only you pension is tax deferred.

Except you can take the money out of the ISA any time. It was in response to Kryton wanting to pay the mortgage off at 57. Not an option if the money is locked into a pension. My preference is to put a bit in the ISA and a bit in the pension. The financial benefits are a bit better for the pension but the accessibility the ISA is handy (especially for me as self employed)

Your pension is likely to less per month than your wages, if you don’t pay into a pension you’ll pay 20% or 40% today in tax + NI. So yes it is tax deferred but also likely to be significantly reduced tax.

+1

Although I don't agree with point 1, investments can grow faster than the interest on the debt. That's how pretty much any well run business works. The investing in an isa or savings account pays less than the debt interest because the bank has to make profit, and is lending that money to businesses who then invest it and make profits. Putting money into a bank account is the least risky thing to do with it, but it's also the bottom of the chain.

You put it in an isa at 1.5%
The bank lends it to a company at 4%
The company invests it in a project aiming to make 20%
etc

My company pays 10% of my salary into a HL portfolio for me, with 5% of that being my contribution deducted from my gross pay, then the other 5% matched by them. I therefore assume i get tax relief via paye and that is why (when i looked at my HL account last night) i cant see tax relief being paid on my HL statement.

That's right - the tax relief in is case being essentially that the tax is never paid. You give up 5%, but your take home only drops by 4%. That difference of 1% would have gone to the tax man (at 20% standard rate, I've assumed).

Your employer adds another 5%, so for a 4% lower take home your pension fund gets 10% of your salary. This will just show up in your pension statement as money arriving.

The key to extra contributions is if your employer will match extra contributions from you: if they will and you contribute an extra £137 and they match it with £137, your pension pot will see an extra £275 a month, and your take home will be £110 less (balancing out the lower monthly on your new mortgage).

If that's the case you've made a great (guaranteed) 'return' on your £110. You've made 150%, right away. This can then grow with your pension fund. Yes you'll pay tax on the way out (in ~20 years, though there are options to get some of it out tax free).

If you won't get a matched contribution from your employer above the 5% they already give you it's not so clear cut. My employer contributions go up until 6% contributions from me, then any further from me don't trigger more from them as an example.

f you won’t get a matched contribution from your employer above the 5% they already give you it’s not so clear cut

Well, this.   Also complicated by the fact that in my case the extra contributions I'm talking about come from Sales commissions, not increased contributions from base salary, so I've already paid tax on them before i invest them.

All workplace pensions now are 5% from you and 3% from your employer, anything more than this would be a bonus. You won’t get any other investment free of tax and with another 60% added to it automatically so it’s not a bad deal really!

Right, I got this, might be helpful for the OP but I'll use my own circumstances to explain.

Essentially by paying more on a monthly contribution to your pension you are getting and extra 20/40% via tax relief that you won't get by paying off the the mortgage.

In my case, I have an employer SIPP and can pay lump sums in via debit card.   Those lump sums automatically attract 20% additional - pay in £1000 and your pot goes up by £1250.   In addition most funds are invested with an aim to increase value so you could end up with more (pensions can go down as well as up!).

I can take funds from my SIPP age 55 - 2 years earlier than my current mortgage ends.  I can withdraw 25% of those pension funds as a lump sum to pay off the remainder of the mortgage, or if I'm gainfully employed I won't, and I'll have 120% or 140% of my sales commissions to enjoy later in life...