When deciding whether to eliminate the debt that overhangs your head or save money is a common question you may ask yourself. Most families are often forced to pay off their mortgages instead of saving their money for retirement. However, they both have their positives and negatives.
The Pros Of Paying Your Mortgage First
There are many people who will pay the same mortgage fee each month instead of paying a lot more upfront first. There is a reason for that and it is due to the initial deposit they placed on the house. However, just because you had to pay £20,000 for your home does not mean you don’t have to spend more than that. If you plan on paying off the remainder of the mortgage at the final stretch of the payment, then it might be worth considering paying it into your mortgage sooner rather than later.
If you pay more upfront in the early stages of the mortgage, including more mortgage fees per month, you will be paying less in interest on your loan over the years to come. However, the same goes for investing more money into your savings/ retirement funds too of course.
An Example Of Paying Your Mortgage
Let me give you an example of the benefits of those extra payments in the early stages of your mortgage. For example, you have a 30-year fixed £200,000 loan with a rate of 4.38%. The lifetime interest is £159,485 if you pay in 12 monthly instalments each year. However, if you make an extra payment each year, you would save £27,216 in interest. Furthermore, if you paid an additional £200 per month, you would save a total of £50,745 and have the mortgage paid off early.
The Pros Of Paying For Early Retirement or Savings
Despite the positives of paying off your mortgage early, there are also positives to starting your retirement savings earlier as well. Due to compound interest, the value of the pound now is far more valuable than a pound in 10 or 20 years. The reason is because of the interest you gain in those years of being in your retirement/ savings pot. Additionally, the interest will also be earning interest. Basically, each year you delay putting money away into your savings account, the less money you will have in 20 or 30 years.
That is why more people are saving for retirement at an early age. Simply because the value will increase more the longer it goes on. If you like to calculate how much money your finances will increase over time, many calculators can help you understand your future savings pot.
If you’re not keen on doing this yourself, and you pay into a workplace pension, you could ask your HR/payroll departments if you could contribute more to this instead.
Investing Your Money Vs Paying Your Mortgage
So, which is better to do? Pay off your mortgage first or invest in your retirement pot. Let’s compare the two with examples. A 30-year mortgage of £150,000 has a fixed interest rate of 4.5% will result in you paying £123,609 in interest during the life of the loan. That is under the assumption that you pay £760 per month. However, if you pay an additional £188 on top of the £760, you will pay off your mortgage in 20 years as well as save £46,000 in interest.
How great does that sound?!
However, investing your money could be far more beneficial.
Say you pay that monthly loan (£948) and you use the additional £188 for investing, you would have earned between £52,000 to £98,000 ahead of the sum you saved in interest, if the return each year was on average 7%. Although this may seem small, if you continue to invest £188, you roughly end up with an additional £230,000 in earnings. The long-term investment is far more beneficial compared to paying off your mortgage earlier.
Is It Possible To Pay Both At The Same Time?
Yes, it is possible however it depends on your financial goals and where you want to be in 30 years. Nonetheless, if you can, try to do a bit of both at the time as both can benefit you. The earlier you do this, the more money you will have in 30+ years.
One thing that you must remember is individual circumstances. Just because your next-door neighbour is paying extra into their retirement pot and paying extra on top of their mortgage does not necessarily mean you can do that. There might be unexpected expenses which you have to pay off and therefore, struggle to pay those extra mortgage fees as well as put money into your retirement pot.
If your mortgage interest rate is more than anticipated, you should spend more money on your mortgage as you can pay it off earlier and avoid the extra interest fees. It can also happen the other way around. If the gain is much higher in stocks or savings, you should put more money into them.
Why Should You Prioritise Paying Your Mortgage?
If you are determined to live a mortgage-free life in your later years, it is best to start paying off the mortgage earlier rather than later to make that dream happen!
Why Prioritise Savings More?
The reason behind prioritising retirement savings more is simple. Compound interest will have a massive effect on the money you put in your 20s compared to your 30s. The value will increase over time and you have the potential to have a much more comfortable retirement. If you don’t prepare well enough for when you no longer want to work, you will need to adapt your choice of lifestyle to live on less.
Final Considerations – Pay off your mortgage or save?
Although paying off your mortgage earlier sounds far better, the returns you get from investing in your savings pot are potentially far greater than the interest rate you don’t pay over the years with your mortgage.
The problem with investing though, is there are no guarantees. Some months the markets can do well, and other times they won’t. You need to be clear on your ability to tolerate risk, and learn about where best to invest your money. Seek help from a professional if you’re not sure what to do.
You could have other debts that are affecting your monthly costs and limiting the amount of money you can put in your savings. Debt unfortuunately sometimes can’t be avoided so make sure you speak to a financial adviser or a charity like Step Change and see how they can help you. You may benefit from using an IVA calculator to see if your debt can be reduced, but be very careful before entering any agreements and seek advice on your personal circumstances first. You might also want to read about IVAs here.
If managing your finances is ever an issue, you could also consider using apps such as plum or money box. These are great apps to keep track of your finances as well as start investing with them with small amounts fiirst to learn more about what to do.