Skip to content Skip to footer

Overpay mortgage or invest? Is it really that obvious?

14–16 minutes to read

Overpay mortgage or invest? This is one of the most frequently asked questions for those with a little extra cash each month. Overpaying your mortgage ensures you clear your mortgage debt quicker and pay less interest. Who doesn’t want that, right? However, investing that cash could potentially offer higher returns. So, which one is best?

Should I overpay my mortgage?

Overpaying your mortgage is unlikely to ever be a bad decision, let’s put that out there first. People who have paid off their mortgage in full report feeling happier.  Knowing you have cleared one of your largest monthly overheads can have a huge boost on your emotional wellbeing. For those starting on the property ladder, this is often a dream that’s 30 plus year’s away.

By overpaying even small amounts, you can reduce your mortgage term by years and sometimes, depending on how much cash you have free, by decades. That piece of mind sounds pretty good to me.

Back in them days...

However, interest rates are currently at historical lows, so the mindset that our parents used to have does not necessarily ring true today. Why? Because unlike them, we are not paying 8-12% interest rates on mortgages. At 8%, a borrower with a £200k mortgage would be paying over £1,300 per month in interest alone.

Whilst these rates haven’t been seen since the 1990’s, there is always the chance we could see them again at some point. And this is the crux of the question; can you make more money investing your spare cash than you would save in interest costs by overpaying your mortgage?

Heads up – We aim to produce honest and accurate content, however, we are not financial advisors. If you need financial advice, Unbiased can connect you with a suitable professional for free. Some of our links may earn us a small commission to help us run the site.

Overpay mortgage - the pros and cons

Pros:

  • Pay off the mortgage quicker to own the asset
  • Pay less interest
  • Reduce Loan to Value sooner and access better interest rates
  • Can be better than a savings account (as current rates are so low)
  • A greater feeling of security by owning your home sooner
  • Likelihood of increased equity in your home
  • Reduced overheads once you reach (early) retirement

Cons:

  • Other asset classes may offer better returns (eg investing, starting a business)
  • Your capital is less liquid (harder to access) if you need it
  • You are potentially focussing your ‘wealth’ in one asset class (ie, your house) and are subject to housing market fluctuations.

Overpay mortgage or invest? Do this first...

Before you consider if overpaying your mortgage or investing is a better financial decision, it’s important to make sure you have solid financial foundations. The following three steps will help build that solid foundation to build your decision on:

1. Pay off other debt first

Paying off consumer debt such as credit cards and personal loans should always be prioritised above overpaying your mortgage. Why? Because short term debt like Credit Cards and Loans usually always carry higher interest charges. If you funnel your spare cash into paying down your loan and not into repaying debt, you will actually be losing more money.

The chart below is for illustrative purposes and makes assumptions on interest rates.

The chart above shows the difference between paying £1,000 towards a 2% mortgage vs paying it towards a debt carrying 5% interest. In this example, paying down the debt saves £30 interest per year. The numbers suggest, therefore, that it is better to pay down the debt. And of course, most debt carries a higher interest rate than 5%. A typical credit card could be charging 18% per year.

Mortgages are usually a very cost-effective way of borrowing money. Loans and debt are usually not due to their high interest. This is why paying your debt should be prioritised.

Double bubble

Additionally, paying down your debt has a double impact, as once cleared it frees up more spare cash per month. You no longer have those minimum monthly payments, so that extra cash can be funnelled into your choice of mortgage, savings or investments.

If you need help or would like to build a plan for paying off debt, then make sure you check out the Debt Learning Track. This has been created by Mike who has paid off £30k in debt over the last few years. He’s been there, got the t-shirt and is now trying to help others in need.

If you have a Student Loan then things are going to get a little more complicated and it’s outside of the scope of this article. Here’s a link to Money Saving Expert, these guys have covered this complex question in detail here.

2. Make sure you have an Emergency Fund

After clearing your debt, you’ll want to ensure you have a little financial breathing space. An Emergency Fund ensures you have enough easily accessible cash to cover unforeseen circumstances or emergencies that may crop up.

As a homeowner, you are now responsible for the maintenance and upkeep of your house as well as paying the mortgage each month. An Emergency Fund covers you in case your boiler breaks down, your roof springs a leak or even if you should lose your job.

Without an emergency fund, you risk not having the cash to hand to pay your bills including your mortgage. Of course, if you don’t pay your mortgage then you risk losing your house.

Any overpayments to your mortgage are usually locked away with your provider, making it really hard to get hold of. If you have an Emergency Fund then you won’t need to access any overpayments you have made.

If you want to learn more about Emergency Funds check out the articles below:

Emergency Savings – How much should you have?

Emergency Savings – Where should they be?

3. Consider lowering your LTV first

The best mortgage rates are saved for those who have more equity in their property. Equity is the amount of the property you own, which is the difference between what you could sell for (the ‘market value’) and what you owe on the mortgage. The remaining property value is owed to the bank via your mortgage.

The proportion of the mortgage vs the market value is also called Loan to Value or LTV. An LTV of 80% means you still owe 80% of the house value to the bank or conversely, you own 20% equity in your property.

For example, if your house is worth £250,000 and your mortgage is £200,000, then 80% of the value is owed to the mortgage loan. This would be 80% LTV. The remaining £50,000, which is 20% of the £200,000 market value, is your equity. If you sold today for £200,000 and paid the bank back £200,000, you would be left with £50,000.

A lower percentage LTV means that if you stopped paying the mortgage and the bank had to sell your house, they have less to recoup, which lowers their risk. As a reward, you pay a lower interest charge each month.

Those starting out on the property ladder with a higher LTV are also subject to the highest interest rates as they are perceived as a higher risk. This means you are paying more in interest every month and less off the balance of your mortgage.

Diminishing returns

There is however a tipping point where mortgage interest rates start getting cheaper. The table below compares the interest you would be paying on a £200k mortgage each year with different LTVs:

Loan to Value Mortgage rate Interest per year
95% 3.89% £7,780
90% 2.99% £5,980
80% 2.24% £4,480
75% 1.79% £3,580
60% 1.31% £2,620

As you can see, the amount of interest you pay each year drops significantly as your LTV reduces. While this is just a snapshot in time of the mortgage rates available, it shows the significant difference lowering your LTV has. The difference between the top rate and the bottom is over £5,000 per year!

By lowering your LTV you also open up the mortgage market to more lenders and better rates. Banks scramble to offer great deals on what they would consider lower-risk loans. This becomes a beauty parade as mortgage lenders one up to appeal to those with a lower LTV!

However, as you can see, once you get below 75-80% LTV, then the savings on offer actually start to reduce.

In summary then, if you have a high LTV above 80%, then perhaps overpaying the mortgage to reduce this is the next place to start. However, if you are at or below this point, then perhaps you should consider which will give you better returns: overpaying your mortgage or start/increase investing.

SIGN UP - IT'S FREE!

Get your FREE financial guides, plus useful updates and exclusives to grow your personal wealth.

Get your house in order

If you haven’t paid off consumer debt, built an Emergency Fund and lowered your LTV, then getting these straight first is usually the most sensible plan. Lots of people get excited about investing and want to jump straight in before getting their affairs in order first. Remember though, investing carries risk and returns are not guaranteed. By getting your financial affairs straight, you build a solid platform to start your investing journey from. Without this, you create additional risk and stress which can have an impact on your mental and physical health.

If you’d like a guide to building a solid financial foundation, then check out our Financial Fitness Programme. It’s been developed to put everything in one place, using simple steps to develop your financial fitness. If you subscribe (above) we’ll even give you the first module free to get started.

It's all about interest rates

Fundamentally, the decision to overpay your mortgage or invest is down will be heavily influenced by interest rates. Having a low-interest mortgage makes investing potentially more attractive because investments typically return higher rates over the long term. However, as always with investing, anything can happen.

What returns can I get from investing?

If you are new to investing or want to learn a bit more, we have written a Beginners Guide to Investing to get you started. We recommend you read this first before diving straight in. It will walk you through the basic principles, options and terminology.

When people often talk about amazing investing returns, what they are usually talking about is the average returns over a (long) period of time. With this in mind, you should only invest if you plan to leave your money in place for a decent period of time, where that average has a chance of being realised. Most people will use at least 5 to 10 years as a guideline.

Even reviewing your investment returns on an annual basis can show what a real rollercoaster it can be. The table below shows annual performance and the average FTSE All-Share Index returns over a 20 year period (source).

Average FTSE All-Share Returns 20 years

You can see that there are years of huge growth, years of huge losses and actually very few years that are close to the average (red line).

However, the average is what we have to work with and that is why keeping your money invested over the long term is so important.

For example, let’s say you started investing in 1999 and that year you saw a 10% drop in your investments. At that point, most people are likely to get the jitters and sell. You’d write it off as a hair-brained scheme to make money and move on. By doing this though, you would have missed out on the next three years of 10%+ growth, recovering all your losses and then actually gain.

Investing provides no guarantees

Importantly, investors need to realise that historical averages are not guarantees of future performance. We never know what’s around the corner and how that will impact our investments.

Because of this, Warren Buffet recommends investing in Index Trackers instead of trying to pick individual stocks. Whilst this strategy seeks to spread the risk, it cannot eliminate it altogether.

Investing isn’t for everyone. I started out by opening up an investment account with Hargreaves Lansdown (one of the biggest UK platforms) and invested £50 per month in the Vanguard Lifestrategy 100 index tracker. Doing this is a good test to see if it’s for you and observing how your money goes up and down. If you don’t like the fluctuations, then maybe investing isn’t for you.

Remember, for most people starting small to learn is a good place to start. If you’d like to talk to other like-minded individuals and hear their journys, then check out our Personal Finance Club on Facebook.

What about house price increases?

Property is considered by many as a great long-term investment. Remember, if you are a homeowner, then you have already made the decision to invest in property. If house prices go up, whether you overpay the mortgage or invest makes no difference. A house price increase of £10,000 is an increase regardless of your choice.

By paying down your mortgage you increase your equity. However, you lock away that cash and make it very hard to access If you choose to only pay down your mortgage, then you are exposed only to the property market. This means the breadth of your wealth is very shallow and focused on only one asset class; property.

Investors will talk about creating a diverse portfolio to ensure you are not adversely impacted if something happens to a particular sector or asset class. Investing in other asset classes, such as stocks and shares, can broaden your wealth allocation and so reduce your risk against one sector.

When not to invest

  • Consumer debt – it’s costing you money, so get this cleared first as a priority.
  • No Emergency Fund – build yourself a solid financial safety-net first.
  • If you need the money in the next few years – investing should be for the long term.
  • You struggle to save – those who struggle not to spend money that is sitting in savings or investing accounts might be better off locking their money away in their property.
  • If you like guarantees – there are no guarantees with investing and fluctuations should be expected.

The mathematical answer

The mathematical answer to ‘should I overpay my mortgage?’ is fairly straightforward. If you can earn a rate of interest or return that is higher than your mortgage rate, then it’s better to put your cash elsewhere. The chart below compares a typical mortgage rate (at time of writing) vs average stock market returns (according to Vanguard).

Comparing the two is a no brainer, right? Well yes, according to the illustration, investing should on average beat overpaying your mortgage. However, in reality, investing rarely returns an average.

The above example shows the difference using £100 per month. The end result after a year is that investing could make you £70 better off. In the grand scheme of your finances, though, it’s only £70. That amount of money is not going to make anyone rich in the short term. You could make better returns switching current accounts or by doing some overtime one week.

At Eat Sleep Money, we are split. I invest my spare cash and don’t overpay my mortgage; however, Mike does the opposite. He has re-mortgaged his property to leverage capital to start a business. Part of the deal he made to himself when doing this, was to pay this back by overpaying the mortgage to get the LTV back down.

And this is what it really boils down to, your personal situation, past experiences and appetite for risk.

Financial Fitness Guide - FREE part1!

Subrscribe now and get your FREE part one of the Financial Fitness Guide, designed to grow your personal wealth, reduce your money worries and give you more time.

Making things simple with an ISA

If you do choose to invest, then you are going to need to consider tax. Thankfully, this doesn’t have to be complex. Most investors will wrap their investments into a Stocks and Shares ISA. This allows you to invest up to £20,000 per year without having to worry about tax. Remember though, if you have other types of ISA such as a cash ISA, then this also counts towards your £20,000 per year limit. Learn more about ISAs here.

An ISA ensures no complex tax returns on any profits that you might make. If you’d like to learn more then check out this article on Stocks and Shares ISAs.

If you are considering an ISA, then we have written reviews on some of the best-known platforms:

If you are looking for an easy platform to start your investing journey, then a popular option is Hargreaves Lansdown. It is considered to have one of the easiest platforms and mobile apps out there and allow you to start with very little. You can also move to another platform for free should you choose a different provider in future.

Overpay the mortgage or invest - conclusion

We’ve outlined the financial foundations you should build before considering this question and highlighted some of the pros and cons of overpaying your mortgage.

Investing has come out the winner mathematically, but things can always change. Furthermore, will you sleep easy at night knowing your money is at risk? And of course, does investing carry enough upside to make it worth that risk? Only you can answer these questions based on your personal circumstances.

Rest assured knowing that whichever way you choose, having spare cash to make this a question you need an answer to, is a good position to be in. The fact you are here reading this article shows you’re on the right path.

Here’s to Financial Fitness

EatSleepMoney.co.uk does not offer financial advice and is intended for reference/information only. Remember, you should always carry out your own research and/or take specific professional advice before choosing any financial products or services or undertaking any business or financial venture. If you need financial advice Unbiased can connect you with a suitable professional for free. Investments may go up as well as down and you may get back less than you put in.