Nest Egg: Should you pay off your mortgage or invest your savings?

Mortgage repayments are the biggest monthly expense for most homeowners.

So, it’s no wonder that many people ask if it is smart to pay off your mortgage early.

While using savings to pay off the mortgage early can ease quite a big burden, this is not a decision to be taken lightly.

We get asked this a lot by couples when they sit in front of us to put a financial plan in place and it’s not all about the numbers. There’s a sleep-at-night factor that cannot be put into a spreadsheet or formula whereby you may feel more secure with less, or no debt. There’s no right or wrong answer and everyone will have different motivations and objectives.

Working out what to do with a big lump sum or a spare bit of cash is one of the nicer financial problems to have.

Using the money to pay down your mortgage or to invest – perhaps in shares – are both options.

The first will save you money on your home loan every month while the second option will give you the opportunity to build a nest-egg through the returns generated by your investments. This could, for example, help fund a more comfortable retirement. Before you pay off your mortgage or get investing, there are several factors to bear in mind.

Do you have emergency savings? It is important to have a rainy-day fund – money on hand in the event of a financial emergency. That could be anything from a broken boiler to a big bill for car repairs, to losing your job. For these reasons, it is recommended that you keep between three and six months’ worth of your net salary in an instant access savings account

Do you have other debts? You should also think about any other debts you may have, such as credit cards, overdrafts or personal loans. The interest you will be paying on these is likely to be higher than the interest saved on your mortgage. The interest may also be higher than the returns you would get from investing. By repaying these debts, you can still give your overall finances a boost. This is because less of your monthly income is needed to cover the repayments.

Are you paying into a pension? If you aren’t already paying into a pension, you very probably should be. Contributions to pension schemes benefit from tax relief, and if you have access to a workplace scheme, your employer will pay in too, making them a very cost-effective way to save for retirement. This does also represent a form of investment, albeit a very long-term one, as your money will go into the financial markets and grow over time.

One of the biggest advantages of paying off all or part of your mortgage early is the reduction it will bring in your monthly outgoings. This should then leave you with more disposable income monthly which will open up options to save or contribute to your pension. You will of course reduce your overall interest bill payable to the bank or building society if you pay your home loan off early and pay a lot less interest than if you stuck to the original loan term. However, there are downsides to handing over your savings to the bank to clear your mortgage.

One of the disadvantages of paying a lump sum off your mortgage early is that once those savings are gone and have been handed over to the bank, then they are gone for good. You will then have to rebuild that nest egg and of course, if you do require an injection of cash by way of a home improvement or car loan, then the bank will charge you a much higher rate than your mortgage rate.

Consider too the historically low mortgage rates that persist right now in the market. The mortgage debt you have right now is probably at one of the lowest interest rates that has ever been seen available to retail borrowers.

Sure, rates will probably rise to combat inflation in the coming years but that won’t be material for a good while yet. It makes sense to consider your investment options of course where you might get an annual return of four or five per cent.

The simple maths here would suggest this is a better use of your savings in the medium term that giving it to the bank to clear debt of one or two per cent. But of course, it does depend on each borrower and if you are comfortable investing your spare cash. One way or the other, the decision to pay down your mortgage in part or in full shouldn’t be entered into lightly and all the pros and cons should be discussed with an unbiased financial advisor.