Pay the mortgage or invest?

The rising prospect of mortgage interest rates of 5 percent or even 6 percent in the UK means that so-called good debt could give your standard of living a horrible squeeze.

Your mortgage debt is considered good because it is largely held to help make you richer – it creates equity in an asset that you anticipate will increase in value. When the highest earners could borrow £ 500,000 at a cost of as little as £ 600 per month, we shouldn’t be surprised that they chose to stretch.

But the same loan that needs repayments of over £ 2,000 per month may not be that good, especially when it goes with rising energy bills.

The new average two-year fixed-rate mortgage surpassed 4% in August for the first time since the beginning of 2013. Amidst the turmoil of the pound and the surge in British government bond yields in recent days, the forecasts of Mortgage rates rising to 6 percent scares borrowers. They are struggling for today’s fixed rate offers, although some lenders have temporarily suspended some offers.

Those with two-year fixed-rate deals are finding that the overall average rate is 2 percentage points higher than when they secured their deal, averaging over £ 200 per month more, according to the Moneyfacts comparison website.

Meanwhile, the price of new mortgages has risen faster than UK interest rates. Hence, last week’s hike in the Bank of England’s principal interest rate to 2.25%, and likely further hikes, could cause even more acute pain for 40% of fixed-rate borrowers who will expire this year. year or next.

For ultra conservative bank cash accumulators that are rapidly losing value due to inflation, this is a good time to make a mortgage down payment. It is, as they say, child’s play.

But should those lucky enough to have portfolios of stocks or plan to start investing cash in on their holdings or scrape their plans and pay the mortgage instead?

Over the past 10 years, many investors have felt confident they can generate returns above the cost of debt. But average mortgage rates are now several steps closer to long-term average returns on equities: in the past, about 7 percent a year above inflation; in the next 5-10 years it is likely to be lower.

A grim prophet, Stephen Clapham, founder of investor education consultancy Behind the Balance Sheet, told the audience at the recent FT Weekend Festival that it would be a good result over the next five years if they can beat inflation and not lose. money on their investments.

Matt Conradi, head of client advisory at Netwealth Investments, told festival attendees it’s less obvious that investors could beat their mortgage costs as rates rise and markets struggle to digest the impact of inflation.

“Over the long term, we are more confident that investments will generate significantly better returns than the cost of a mortgage. However, in the short term, with mortgage rates on the rise and market uncertainty, if you are a higher rate taxpayer, the balance of risks is shifting towards the certainty that mortgage repayment offers. ”

If you still decide to favor the investment path, there are steps you can take to improve your returns.

First, don’t miss the opportunity to have tax-protected growth in individual savings accounts (Isas) and pensions.

ISAS provides tax-free income on retirement and can give you the flexibility to retire or cut your job before retirement. Your Isa annual allowance is £ 20,000 and remember your spouse has one too.

With pensions, the tax relief on entry in addition to ongoing tax-free growth can have a greater impact, despite the potential payment of withdrawal taxes.

If you use the full £ 40,000 annual pension contribution allowance and get higher tax relief, it costs you just £ 24,000. This is an instant 66% increase on your investment. Where else can you get it without taking excessive risks? Yes, he’s locked up for up to 10 years before your state retirement age, but after that you can take 25% tax free.

Netwealth compared a down payment on a mortgage of £ 10,000 with the potential outcome of a retirement investment. Over 20 years, with a fixed rate of 5 per cent, the mortgage would amount to £ 26,533. If retirement grew at an average of 5.2%, Netwealth’s estimated returns on a portfolio invested 90% in equities and 10% in bonds would have a cumulative net mortgage benefit of £ 2,487 for a taxpayer. base rate and £ 5,237 for a higher tax payer.

However, using the same growth assumptions over a 6% mortgage, the benefits of retirement are reduced, with the advance of the winning mortgage for both the basic and higher taxpayers, albeit just £ 300 for the higher taxpayers.

If you have already used Isa Annual Pension and Annual Benefits, you will invest using a taxable general investment account. A tax-efficient way for those who are cashing out investments in a general investment account that has increased in value would be to use the annual capital gains tax allowance of £ 12,300 to overpay.

It might be worth doing. Using the same 5.2% growth assumptions over 20 years, Netwealth calculates that a base rate taxpayer who chooses to invest could lose £ 4,333 compared to the certainty of paying off a 5% mortgage and a higher rate taxpayer could lose. £ 8,633. On a 6% mortgage the potential losses are £ 9,871 and £ 14,171.

You should take high risks: invest 100% in stocks and aim for punchy annual returns of 10% or more to make the investment the potential overall winner. And you could always lose.

But, if you’re determined to keep investing, here’s some comfort.

It is difficult to immediately access all the extra money you put into the mortgage, for example if you have lost your job or have had a period of poor health. Since the recession is around the corner, you may want that financial flexibility.

Also, keep in mind that the average homeowner is overexposed to residential ownership. So, be careful to increase it. Real estate pundits expect the cost of living crisis to reduce what has been the rapid rise in property prices (despite the government’s boost to business from a new stamp duty incentive).

Calculate the value of the equity held in your home as a percentage of your total equity. Some UK financial advisors recommend that 30% of net wealth in residential properties be ideal. You may already have much higher exposure.

Being a borrower with a fixed rate mortgage is a classic hedge against inflation. The value of your home may go up, but your fixed rate loan will not change and it may seem less onerous after a few years of higher inflation reducing the purchasing power of our pounds. Sure, your home may go down in value but, in the long run, it wasn’t the British experience.

Note that these are mostly rational arguments. Emotion will also play a role in your decision.

Your personal risk tolerance is different from that of your friend or relative, or even your younger self. As you create wealth, a little more can make less of a difference in your life. You could simply choose to reduce your risk rather than increase your returns.

How would you feel, think or live differently if you didn’t have a mortgage? If your mortgage seems like a mental burden, prevents you from changing careers, or stirs up arguments at home, make it your priority.

Not everyone wants to collect art, fly first class or drive a Porsche. If being mortgage free is your favorite luxury, a status symbol that simply makes you feel good, it’s perfectly valid.

Either way, paying off debt doesn’t have to be forever. It may be possible to get a larger mortgage later. Just don’t count on interest rates returning to historic lows.

Moira O’Neill is a freelance money and investment writer. Twitter @MoiraONeill and Instagram @MoiraOnMoney

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