Last updated in November 2020
Making a decision of whether to overpay your mortgage or invest can be tough. This is especially true for those aiming for financial independence, retire early (FIRE). Financial independence means freedom, but can you be truly free while having a mortgage?
There is a lot of unclarity surrounding the question of whether you should overpay your mortgage or invest. And there is a reason for this. The answer is not straightforward and depends upon a multitude of factors.
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Table of Contents
Should you overpay your mortgage or invest for FIRE?
Other factors to consider
First of all, before thinking about overpaying your mortgage or investing your money, you should create an emergency fund. This will protect you in case of emergencies, for example, if you lose your job or become ill.
Typically, an emergency fund should cover your living expenses for three to six months. If your income is very variable, you may want to save up to 12 months’ worth of living expenses in your emergency fund.
Your emergency fund is your most important savings pot and you should always prioritise this over anything else, except perhaps repaying high-interest debts.
Another point to consider is any other debt you may have. Unless it is interest free, you should pay off any other debt before overpaying your mortgage or investing.
This is because in the vast majority of cases the interest on your debt is higher than any return from investing or overpaying your mortgage. Plus, having debt is always associated with risk. If something unforeseen happens and you cannot make minimum payments on your debt, you would have to take money out of your investment account at a bad time.
Plans for your future include factors such as going to university to study, trying to have a baby, having a big wedding, etc. All these events can be potentially expensive.
If you are undecided on whether to overpay your mortgage or invest your money, you should ensure beforehand that you do not have any large expected cost lying ahead. If you do, make sure you keep enough money in your savings account to cover these.
Should you overpay your mortgage or invest?
When you get your mortgage, your lender will work out how much you have to repay every month to ensure your mortgage gets paid off at the end of the term. The calculation will take into account the interest rate of the mortgage, the number of years you will be repaying your mortgage, and the amount you owe.
Overpaying your mortgage means increasing your mortgage payments to pay back a higher amount of money than you agreed with the bank. You can do this either with higher monthly payments or as a lump sum. The aim of overpaying your mortgage is to save money in the long term.
The benefits of overpaying your mortgage include:
- Paying less interest on your mortgage (saving money)
- Achieving freedom because you are no longer bound to the bank
Investing your money means buying stocks and shares, funds, commodities or even other properties than your residence. While there are many things you can invest in, for this article, I will assume the investment of choice is an index tracker. This is what most sensible non-expert (or simply lazy) investors invest in.
The aim of investing is to generate a recurring income from your assets (make money in the long term). With an index tracker, the profit comes from the growth of the individual shares in the fund.
The benefits of investing in include:
- Establishing new income streams
- Benefit from periods of high economic growth
- Diversification (one fund contains stocks from many different companies in different sectors)
Whether you should overpay your mortgage or invest is a tricky question. There is no right or wrong answer and one size does not fit all. However, here are some factors you may wish to consider:
Looking at the issue from a purely financial perspective, investing almost always outperforms overpaying your mortgage. Assuming your money is sensibly invested in an index tracker, you can expect a 7% growth per year. Note that 2% of this growth are attributed to inflation (price increase).
Note that these 7% are an average value. In some years, your fund may grow 20%, but in others, it may fall by -20%. Investing is a long-term game, and you should be prepared to leave your money in the market for five to ten years.
On the other hand, your mortgage interest is likely to be less than 7%. Interest rates vary and depend on many factors. Assuming you are paying 3.5% interest on your mortgage, you would, over time, gain an advantage by investing. Note that this may not be immediately apparent.
Additionally, investing money in the stock market comes with the benefit that the money is more liquid than if you had overpaid your mortgage. This is because selling stocks is easy compared to releasing equity from your house. Although selling stocks at the wrong time may come with a penalty, it can be useful during an emergency.
Apart from the most financially sensible course of action, you should also take into account psychological factors. Owning your house can give you a feeling of safety and security. By paying your mortgage off sooner, you are reducing the total amount of debt you have. Some people find it depressing owing a vast sum of money to the bank.
Additionally, living in a home you own vs. living in a home that is owned mostly by the bank can feel differently. For some people, these fine details hardly matter. For others, they mean a difference like night and day.
Neither of these viewpoints is right or wrong. You only have one life so you should do what makes you feel most comfortable. Being stressed out and worried can have detrimental effects on your life that are much worse than the small amount of money you lose by overpaying your mortgage versus investing.
Time to financial independence
Time to financial independence is less important but nonetheless a point you may want to consider. It is worth keeping in mind that just paying off your mortgage will not make you financially independent. You will still have to cover the costs of all other life aspects.
There are different scenarios to consider:
- You want to be financially independent before paying off your mortgage
- You want to be financially independent after paying off your mortgage
Thus, your approach may be influenced by your time to financial independence. If you want to reach financial Independence after you paid off your mortgage, overpaying is the right choice.
If you want to retire earlier, investing your money is a more sensible decision. This means you can live from your funds and pay your mortgage from the growth of your stocks.
So what should you do?
Ultimately, your life is yours to life. Whether you should overpay your mortgage or invest is up to you. As the decision of whether to overpay your mortgage or invest is not an easy one to make, it is best you take your time to consider the advantages and disadvantages of each choice.
If you can live with the psychological implications, investing your money is likely the better choice. However, if you prefer freedom from your bank and fully owning your home, overpaying your mortgage is probably the best choice for you.
When making your decision, keep in mind that nothing is set in stone. If you change your mind later on, you can simply take out money from your investments and use it to overpay your mortgage (under the condition that it is the right time to sell).
If you re-consider your choice on whether to overpay your mortgage or invest and would like to invest rather than overpay your mortgage, you can simply stop overpaying. Instead, you can use the money to invest instead.
If you really want to go all the way into investing, you can release equity from your property and invest this money. However, this is more complicated and you may want to consult a financial advisor for this. The important point is that there is flexibility for your decision.
Should you overpay your mortgage or invest for FIRE? summary
The question of whether to overpay your mortgage or invest is not easy to answer. This post provides you with important points you may wish to consider, such as:
- Financial factors
- Psychological factors
- Time to financial independence
However, ultimately, the decision is yours to make and you should do whatever you feel most comfortable with. If you are unhappy with your choice, you can always switch between overpaying your mortgage and investing later.
Read more to find out whether you should buy a property or invest in your pension. You may also wonder whether increasing your income or reducing your expenses is the more effective way to amass savings.
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