Overpaying mortgage 4% vs ISA investment 6%

[Cupboardlovely]

Please could someone explain this to me?

I keep reading posts about how it is unwise to pay off your mortgage early. That, if you have spare money, it’s better to invest it, or put into an ISA if the % is higher than the interest I’m paying on my mortgage.

I understand the theory of that.

However, it’s 4% on my mortgage of £300,000 so that interest I am paying is 4% of 300,000 (high!)

Verses potentially gaining 8% on what I currently have in my ISA (I have £40,000 in my ISA)

(This week my Stocks and shares ISA is on between 6-8%.)

So with these numbers, surely I will be better off overpaying more on my mortgage?

I think you are getting confused because the amounts are so different. 4% on £300,000 is much more than 6-8% on £40,000.

But it is the percentages that matter.

For example, if you were to take your £40,000 and pay it off your mortgage, you would save £40,000 x 0.04 = £1,600.00/ year. Whereas you would lose £40,000 x 0.06 = £2,400 / year.

So can you see how it is the percentage that matters and you should maximise the amount with the higher percentage?

Thank you! This must be where I am going wrong.

So, it is much better for me to put this into my ISA.

Thank you, I don’t have a very mathsy brain

If, for example I have already maxed out my ISA. Where else could I invest any spare money (if I didn’t want to overpay my mortgage)?

No, because if you have £100 to play with, you only save 4% on the mortgage vs 6-8%on the isa. Your money works harder with your ISA.

Over 5 years, you’ll make more money on the isa than you would save by overpaying. You then take a big chunk off the mortgage at once.

Depends on your tax status and whether you are looking long or short term.

You would need to make 4% after tax in a savings/investment account to beat the mortgage. That's hard if you are a higher rate tax payer.

Ah yes I see what you mean, as any earnings from investments outside of an ISA are taxable.

I am a higher rate tax payer (£100,000) and wanting to save long term.
So anything I earn over £100,000 will get taxed very heavily, so I am thinking the most sensible option is:
max out ISA, then overpay mortgage with anything leftover

—
(I am not sure how I’d work out the alternative option of investing and working out the tax on it. I guess something like:
Invest 30,000 per year= modest estimate of 8%
£2,400 interest gained. But then due to my salary, 50% of this will be liable to tax. But I’d also lose my tax free allowance. So effectively 60% (ish) tax. So that would leave a £960 gain.
So this option definitely seems the worse option)

In your position I would also seriously consider paying into a pension, it reduces your income for tax purposes and the investment growth could beat the mortgage rate depending on the underlying investment.

It might be worth paying for a session with a financial planner who can come up with a plan based on your age, circumstances and plans for the future.

Ah yes - if you pay into a pension you get tax relief at source, and can then withdraw it as part of a tax free lump sum later on. Once you draw your pension down, you tend to take a hit on income so your income tax is lower.

It makes sense to load your pension with a view to paying off the mortgage as late as possible, when you can have more tax efficient access to funds that you’ve accumulated via your pension.

1. Ramp up your pension payments especially if you can do it through your employer. Monitor where this pension is invested and if it’s active (expensive fee) funds also open a SIPP (private pension) with Vanguard and invest in S&P 500 and global all cap index fund (fees of 0.17% and 0.23%).
2. Set up stocks and shares ISA through Vanguard or Interactive Investor. Invest in same funds as I’ve suggested for pension
3. Look at Cathy Wood’s niche tech stocks fund but only if you don’t mind high risk…

I am not a financial adviser but wish I had done all of the above much earlier instead of paying down a mortgage before 40. We are still in the same house. It’s basically over a million quid of non liquid asset just sitting there not working for us especially when property prices are slumping.

Wow thank you so much for this advice.

I could increase my pension contribution , but I do already pay quite a lot (£2,000) into it straight from my business. (It’s managed by SJP)

Im going to look into SIPP as I don’t know anything about these. And I don’t really understand s and p 500, but I hear a lot about it.

OMG @Cupboardlovely pleade please please get away from SJP now!!! They’re truly terrible and have been accused of over charging customers by the FCA no less who are normally very conservative. I implore you to pause and google Rebel Finance School and watch each episode. If you’re paying yourself then you need to go to a decent fairly priced platform like Vanguard or maybe interactive investor. I am NOT an IFA but I have learned more than ever watching the Donegans of Rebel Finance School. While the funds I suggested have done well, it’s not an indication they will continue to do so. But SJP are known officially as being the worst. Excellent marketing but you need to break up with your IFA and they will tell you how.
To have a moderate income in retirement of say 40k a year you need a pension pot of possible 600-800k by the way but you probably know that!

If you want the more secure option I'd go for the mortgage. The rate may not be 4% forever. Equally, as we're often reminded, the stock market can go down as well as up.

OP the stock market can go up as well as down. But the years it always grows. That’s the difference between volatility and risk. Risk is minimal actually if you’re in a global all cap index passive fund which tracks the top 7000 firms in the world. You may lose money tomorrow but if you look at the overall performance over 10 years, you will make money as the economy grows. I personally wish we had not bothered paying off a mortgage. We would be ISA (low) multi millionaires by now if we had stuffed our ISAs thanks to the magic of compounding.
One of the reasons the average professional in the UK is so skint is (apart from our wages being too low) that we don’t understand very basic economics of the stock market and compound growth. We associate all stock market activity with crashes. There will always be crashes but you are far far more likely to have far more money if you hold your nerve. If anything a drop means your regular investment will buy you more shares. Please never ever put it into a cash ISA.

Is your mortgage a fixed rate and how long have you got left on it?

If I had a variable rate mortgage that you can overpay on, I think I'd keep enough liquid eg ISA that you can take from to pay a chunk if interest rates rise.

Thank you @Petrusplease.
i will check out Rebel finance school. I was aware sjp isn’t liked but unsure exactly why, so I’ll check this company out to educate myself.

i think you are right too. So many of us don’t understand basic financials (like me). I’ve learned a lot in the last couple of years. But will check out rebel finance. Thank you

It’s fixed, but will be moving mortgages next month as it’s come to an end.

SJP have a terrible reputation for high charges and mediocre performance. co

Considering you are already paying for that them you really should consider seeing an IFA, it would save you money long term. You could get some proper planning and get your funds moved away from SJP.

I used to work as an advier and now work in the financial services data industry, SJP were always considered all show and no substance and have recently been reprimanded for their charges. I am sure there are some good advisers working there but you could do much better.

Look at offset accounts for your mortgage. Good for your emergency savings fund and instead of interest earned you save interest on your mortgage so it is payed off earlier. The interest is in effect tax free.

I did test seeking advice from an IFA. But I couldn’t find one that was happy to work on an hourly basis. They all wanted to work on a % basis.

Do you know if there’s a site where I can search for one?

Some good advice above. A certified financial planner might be what you need. They can look at where you are now and your future goals and help you get there. Meaningful money academy on you tube/podcasts is really good at explaining stuff.

Oh gosh, get away from SJP!

Spend a bit of time on the Reddit uk personal finance forum. Most people don’t need financial advisors -they generally add little value. Follow the Reddit flowchart!

That. It is what convinced me that paying down debts is what worked best for me. And the benefits can be immediate.

Has OP clarified they have no other debts, no car loan, no house improvement loan, no high credit card balance, etc. ?

I'm not a higher rate tax payer, maybe that matters.

My other take on it was that paying down the mortgage was a guaranteed benefit whereas the stock market... who knows over what time frame that would be best and what if something happened in meantime to screw up my earnings potential and ability to service the debt. The trick to maximise the option of paying down mortgage is to shorten term as you go, too.

I reckoned that if paying down mortgage freed up disposable income, I could turn around & invest that excess in shares, at any time. Ideally on a regular basis (£££/month). Investing in shares via pension is very tax efficient, as others have pointed out. Another way I looked at this was "Where could I make the biggest mistake?" Unless there are penalties for paying off mortgage early, it's very rarely a bad decision to pay down mortgage rather than gamble on shares. I'm all for asset diversity and am not risk adverse, stocks are fine as assets in a balanced portfolio, just that for me, the evidence was that the most likely maximum gains were from paying down mortgage rather than into another investment.