Thinking of overpaying your mortgage or starting to invest? These are the five questions you should ask yourself.
While the last year has been incredibly difficult for many, many of those lucky enough to have kept their health and jobs throughout the pandemic are now feeling financially stronger. Lockdowns and social distancing limited our opportunities to spend and resulted in Brits putting record amounts of money away – for every £100 received households saved £25.90 on average during the summer of 2020, according to the Office for National Statistics.
The savings habit seems to be sticking. The average household saved nearly 20% of their disposable income in the first three months of this year, a huge jump from the average of 8.5% before the virus emerged.
So, what should you do with your additional savings? As interest rates on cash savings are low – the highest rate currently available on an easy-access cash account is 0.58% with the Online Flexi Saver Account from Investec that requires a £5,000 deposit to secure this rate – two of the most popular options are to make overpayments on a mortgage or start investing.
There are five questions you should ask yourself first, but remember that every situation is individual and you should always seek professional advice before making any decisions.
1. How big is your financial cushion?
Plough your savings into your mortgage and you will not be able to access your money easily, without either selling your home or going through a potentially complex, long or costly process involving remortgaging or equity release.
Savings that are invested in an ISA or general investment account, however, can be withdrawn more easily – Nutmeg returns customers’ money in three to seven days and doesn’t charge for this, although it is worth noting than any used ISA allowance will be lost. (There is an exception with Lifetime ISAs, which have a government-set penalty charge, currently 25%).
Everyone should aim to have at least three months of living costs saved in cash for any unexpected life events. This should be more like six months of living costs if you are single or work in an industry where it can be hard to find employment.
If you have a big enough cushion, you might benefit from investing some of your cash. But investing isn’t a short-term thing. A diversified investment portfolio should be kept for at least three years, and ideally longer, to allow enough time for the investments to mature.
2. How many years are left on your mortgage?
A mortgage is a huge financial commitment not just because it’s a loan of tens or hundreds of thousands, but the length of time it takes to pay back. Twenty-five years used to be the standard term (or length) of a mortgage, but as property prices have risen, it’s more common now for younger people to have to take out a 30-year, 35-year or even a 40-year mortgage to buy a home.
The longer that’s left on your mortgage, the more you will benefit from making overpayments now to reduce its length. Every month you have a mortgage you’re paying interest, so overpayments shrink the amount outstanding and lower the overall amount of interest you’re charged.
Note that this is only for the most common kind of mortgage, called ‘repayment mortgages’. People with interest-only mortgages have special circumstances and should seek tailored advice.
Equally, if you have a relatively short amount of time left on your mortgage, are comfortable with the level of repayments you’re making, perhaps consider investing your spare cash elsewhere.
3. How old will you be when your mortgage is due to be fully paid?
Traditionally banks and building societies offered 25-year mortgages and typically first-time buyers were in their twenties, which meant that people could expect to own a fully-paid for home in their fifties. At that point people are still working and can bump up their retirement savings by paying what would have gone to their mortgage into their pensions.
Soaring house prices have delayed home ownership and the average first-time buyer is now aged 31, with a mortgage that could run into their sixties or seventies. People in this situation will have fewer years of mortgage-free living to focus their efforts on pension saving. Making overpayments to your mortgage now could ease the burden later in life when planning for retirement becomes a pressing financial concern. But contributing to your pension earlier could mean you benefit from compound returns on your investments, so you’ll need to consider which is right for you.
4. How much risk do you want to take?
Whatever you do with your savings there is some kind of risk. Inflation diminishes the value of money over time, so £5,000 today will have lower purchasing power in 20 years’ time.
Investing in assets that rise in value is one way to beat inflation, but there’s also a risk that the price of the investments fall and you lose money.
Many people look at their home as an investment, but again there’s no guarantee that you’ll be able to sell it for more than you paid. But you will always need a place to live and can keep living in your home regardless of how much it’s worth. So, overpaying your mortgage is lower risk than a portfolio of shares in that sense.
5. What’s your mortgage interest rate?
Average interest rates on mortgages are lower than they have ever been. In the seventies it wasn’t unusual for homeowners to be paying 15% interest or more, while today the lowest two-year fixed rate deal charges 0.95%.
A diversified investment portfolio could potentially achieve higher returns over a timeframe of at least five or ten years – but they come with no guarantees, the risk of losing some of your investment and fees are charged too. Even with those caveats, investing could be the better option for some people, particularly those who are already making the maximum amount of overpayments that their mortgage lender will allow, have a substantial emergency fund and want to make the best of surplus cash savings.
As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. A stocks and shares ISA may not be right for everyone and tax rules may change in the future. If you are unsure if an ISA is the right choice for you, please seek financial advice.