After buying a house, many people feel a desire to try to repay their mortgage as quickly as possible. This may be because overpaying a mortgage each month will reduce the amount repaid in the long run, or because it means the person in question is mortgage-free sooner than they otherwise would be.
However, the reality is that in the current economic climate it may be prudent not to overpay a mortgage. Rather, using any excess cash each month to invest in shares for the long term may be the fastest means of retiring early.
At the moment it is possible to fix a mortgage for two years at an interest rate of less than 2%. That’s for a 90% loan-to-value (LTV) mortgage, and is the lowest it has been for many years. Therefore, any amount overpaid on such a mortgage would save less than 2% in debt servicing costs each year.
In contrast, the FTSE 100 currently has a dividend yield of 3.9%. Investing through a tax efficient vehicle such as an ISA will mean that this income will not be taxed – even if the annual dividend allowance is breached. With many of the index’s constituents offering yields in excess of 5% and even 6% in some cases, the income return on shares is significantly higher than the amount saved on overpaying a mortgage.
With Brexit causing significant uncertainty regarding the UK economic outlook, it is unsurprising that CPI inflation has increased to 2.9%. A further weakening of the pound seems likely, since Brexit talks are apparently not progressing as expected.
In some cases, the income return on shares is significantly higher than the amount saved on overpaying a mortgage.
This could be beneficial for the FTSE 100, since it may cause positive foreign currency translation adjustments for the international stocks which are listed on the index. The result of this could be rising share prices which add to the 3.9% income return of the index. This could make investing in shares even more appealing than overpaying on a mortgage.
In addition, higher inflation will help to erode the value of existing debts. Normally, higher inflation would be likely to prompt interest rate rises by the Bank of England. However, with the UK’s economic outlook being uncertain and its growth forecasts having been downgraded, the central bank may prioritise economic growth over the price level. This may keep mortgage rates down for a sustained period – even if a 0.25% interest rate rise may be on the cards in the short run.
Obviously, investing in shares instead of overpaying a mortgage is a riskier move for any individual to make. Shares can go down as well as up, and the return is not guaranteed to exceed the mortgage rate.
However, history shows that in the long run the stock market has a total annual return of around 7-8%. With mortgage rates being so low, it is therefore likely to be a better investment. That’s particularly the case with inflation rising, sterling depreciating and the economic outlook for the UK being uncertain.
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