As a result of increased interest rates, millions of households have experienced a significant rise in their mortgage rate or are preparing for one this year. The Bank of England rate is currently 3.5% and is anticipated to increase to 4.5% soon. After enjoying years of paying interest of less than 2%, many borrowers coming to the end of a fixed-rate agreement will suddenly be remortgaging onto rates around 5%. If you have extra money, you could be considering making extra mortgage payments to get rid of your debt sooner. Others might be considering investing the funds in the hope of receiving a higher return. We examine the two options and consider which might be the best choice for you according to property experts including lettings agents in Edgware.
The advantages of making extra mortgage payments
By paying your mortgage in excess, you can pay less interest overall and pay off your loan sooner. For instance, assuming a 3% interest rate, someone who borrowed £250,000 over the length of a 25-year mortgage would pay £1,186 every month. You could save £22,812 in interest and shorten the length of your mortgage by five years if you paid an extra £200 a month. If you overpay by £200 a month on a mortgage for £250,000 with a 6% interest rate, you will save £57,639 in interest and shorten the length of your loan by six years.
Therefore, paying more than you should when your mortgage rate is higher might have a bigger impact; you can significantly lower your interest payments and reach mortgage freedom sooner.
Should you be paying off your mortgage early?
Generally speaking, paying off your mortgage early is wise financial strategy. There are a few things to think about first, though. According to experts, households should first make sure they have a sufficient financial reserve, equivalent to three to six months’ worth of expenses. This should be kept in a savings account with quick access so that it can be used for any unforeseen costs, such a broken boiler or an unexpectedly high energy bill.
Consumers should pay off their highest interest debt first if they have extra money after three to six months of expenses (credit cards, loans, and overdrafts). Only then should they think about paying down their mortgage if they have no other debt. Try to pay off credit cards and loans first as they are sometimes more expensive than mortgages.
There are two more things to look into if you decide that paying off your mortgage early is the best use of your extra funds. Check to see whether there are any overpayment fines first. Most lenders permit borrowers to make extra payments totaling up to 10% of their outstanding balance each year. If you go beyond this, there may be severe consequences.
Second, confirm that you’re genuinely shortening the term of your mortgage rather than just deferring future payments. This will guarantee that your mortgage is paid off more quickly and with less interest.
Why not put the cash to work investing it?
There is a “opportunity cost” associated with overpaying your mortgage. In other words, might you have earned more money from investing the money than the debt’s interest rate? At least historically, investing in carefully managed and expanding businesses has been a solid strategy to build wealth over many years. However, you must leave your money invested for a considerable amount of time if you want to completely capitalise on the power of the stock market and benefit from compounding gains.
It would therefore have been wiser to invest instead and receive a 5% return on your investments than to pay off your mortgage early at, say, a 3% rate. There may be less of an opportunity cost now that mortgage rates are high; the average two-year fixed-rate mortgage is 5.79%. Bettering a 2% or 3% rate with investment returns is one thing, but consistently earning upwards of 6% is far more challenging. It makes more logical to pay off debt as quickly as feasible when interest rates rise. It’s crucial to consider how much danger you’re willing to assume in addition to comparing the stats.
On the other hand, if your investment strategy is appropriate, compounding returns and investing as much extra money as you can over a long period of time may be a very powerful force.
Is it a wise idea to invest at the moment?
You might be unsure about investing in the markets after last year’s tumultuous year. Due to traders reacting to this new period of runaway inflation, rising interest rates, greater borrowing costs, and the ongoing war between Russia and Ukraine, declines in both equities and bonds in 2022 occurred. The outcome was a 5.7% annual decline in global shares and a 5% annual decline in global bonds, including income.
How can I choose the one that is best for me?
In the end, whether you choose to overpay your mortgage or invest your money relies on your situation, stage of life, and time frame. For instance, it is debatable whether a retiree with an outstanding mortgage should prioritise paying it off first in order to free up money for other living expenditures. In the meantime, a person in their 20s could choose to invest their extra money to profit from the current market conditions. Those who have extra money with a mortgage that is about to expire should utilise it to make extra payments rather than top-up investments if household cash flow is limited.
As real estate values fall, this will become even more crucial because paying more than what is necessary safeguards the loan-to-value ratio, which can determine access to lower mortgage rates. Experts concur that, depending on the amount of extra money available, paying off your mortgage early and making investments could be the best course of action. If you’re planning on remortgaging soon, the first option allows you to get ahead of higher repayments and increases your financial stability while you pay off debt. And investing can help you increase your wealth and beat inflation.