I Stopped Investing and Overpaid My Mortgage… This Is What Happened.

I spent over one month researching whether or not we should start overpaying our mortgages and I was shocked by the result because with the bank of England raising interest rates even higher mortgage rates are through the roof meaning that you get a higher effective rate of return When you overpay your mortgage but it's just not that simple because it turns out that choosing whether or not to overpay your mortgage is probably one of the most complex financial decisions that you will ever have to make there are just so many factors at play and the must behind it is absolutely mind-boggling meaning that making the wrong decision could cost you thousands but I'm on a mission to get to the bottom of this massive conundrum so that I can help you solve a most significant problem that you will face in your financial lives so to get me started on the problem I first had to research the current situation so when we look back at the beginning of the year UK mortgage rates were set at around 3.6 percent so having a 200 000 pound mortgage back then over a 25-year term with a 3.6 interest rate meant that you'd be making monthly repayments of 1012 pounds and you'd be paying back a total of around 300K but then if you decided to make it 200 pound overpayment each month you'd save around 27 000 in total and you finish repaying your mortgage around six years earlier but because the bank of England have been increasing the bank rate throughout the year current mortgage rates are average in around six percent now if we run those exact same numbers as before but with a six percent mortgage rate you now have to make monthly repayments of around 1 289 pounds per month and you're going to be paying back around 385k in total and that means that a 200 pound monthly overpayment is going to save you over 54 Grand and you're going to wipe out your mortgage six years and four months early so I knew that overpaying a mortgage Now is better than it was a year ago but I needed to understand how it compared to investing so this is where it starts to get a little bit confusing because let's say that you take the six percent effective return that you're going to get from overpaying your mortgage and match that up to an investment that's going to earn you six percent per year investing that same 200 pounds per month over in 18 years and eight months period which is the total length of a reduced mortgage is going to earn you around 37k in interest Which is less than the 54k that we saved from overpaying and more mortgage now you might be thinking Lewis it clearly said that you made 82k but this is when most people make the mistake and trust me it's easy to do because you can't just take a 200 pound monthly investment over an 18-year and eight month period and compare that side by side with an overpay mortgage example because in that example you'll have overpaid your mortgage and you'll have no debt left by the end of it but if you pay 200 pounds per month instead after 18 years and eight months you're still going to have six years and four months left on your mortgage which needs to be paid off so for us to run these calculations properly you need to compare both sides over the entire 25-year period so after investing 200 pounds per month earning six percent returns over a 25 year period you'll end up earning a total of 138k so let's just put that to one side but for the overpay mortgage side you don't invest at all for the first 18 years and eight months but then you have to remember that after that period you'll have paid off your mortgage which means you'll have more Capital freedom to invest so that's 1 289 pounds plus the 200 pounds per month and if we invest that over the remaining six years and four months you guessed it we end up with around 138k and this means that investing only becomes better than overpaying your mortgage if you're in a higher rate of return on your Investments then the effective rate of return that you get from overpaying your mortgage but how realistic is this well this is an investment return forecast from Vanguard which was made in May of 2022 and this suggests that Global equities will earn around 4.6 per year on average over the next 10 years now of course you have to take this with a pinch of salt because it is a forecast and forecasts can certainly be wrong but 4.6 is well shy of a six percent that we'd need to match mortgage over payments meaning that for now the mass is in favor of overpaying your mortgage so with a mass out of the way our research mortgage over payments further and I liked what I found because the six percent return that you could get from overpaying your mortgage is way better than you actually think because it is a guaranteed rate of return we're normally really happy if we get a return of 10 or more from the stock market but this data on the returns of global markets over the past 28 years shows how uncertain that return it can be with a quarter of the years providing negative returns but a six percent guaranteed return that is just unheard of in investing and you also get the added benefit of paying down your debts the faster you overpay your mortgage the sooner you will become debt free and that is a feeling that is hard to put a value on but there is no doubt that the psychological benefit of knowing that you own your own home and knowing that you won't have to make monthly payments for housing anymore could be life-changing and it could far outweigh any stock market returns that you could potentially get from investing another benefit of paying down your mortgage is that you could potentially get better interest rates when you have to remortgage because you'd have more equity in your home currently some of the best mortgage rates available require a maximum loan to value ratio of around 60 So the faster that you pay down your mortgage the more likely you are to reach these sorts of levels so I set up my equipment and turned on the camera ready to tell you all that you need to start overpaying your mortgage but then I realized wait a minute I was sat in front of his camera literally a few weeks ago telling you lot that it's actually good to be in debt right now how could I forget from a number's point of view we shouldn't be in a rush to pay off low interest debt whilst interest rates are currently lower than inflation because with mortgage rates at six percent and inflation sat at 10 the money that we're lending is going to be less valuable in the future when we have to pay it back even after you take into account the interest growth we're actually in this weird period where you can profit from being in debt and come to think of it whilst over paying mortgages are offering pretty good rates of return right now so are savings accounts this easy access savings account from Barclays earns you 5.12 interest on savings up to five grand nearly matching the effective rate of return of six percent from overpay mortgages and the best part about this is that the money is easy access meaning that you can get the money out whenever you want should anything pop up even fixed term savings accounts have some flexibility it's not impossible to get that money back you might just have to pay a fee but when you overpay a mortgage that money is as good as gone at least for the short term it's going to be very difficult to get that money back should you really need it one thing that I do want to point out though is that you have to be mindful of taxes when using savings accounts we all have a tax-free allowance on interest based on our total income but after that is used up you will have to pay income tax at your relevant rate that said it's not like overpaying mortgages is a fee-free process because some mortgages are going to charge your early repayment charges which are going to eat into your effective rate of return these are going to vary from mortgage to mortgage so you need to check your own mortgage terms and conditions to make sure that you don't trigger them by overpaying too much another thing to be wary of is that when you overpay a mortgage you're going to be pooling more of your cash into this one asset your home this can lead to investors becoming Overexposed to property and even worse Overexposed to just one property meaning that you can take on a lot of concentration risk if housing prices in your area tanked due to some unforeseen circumstances this could have a catastrophic impact on your net worth but when you compare this to investing in index funds you can easily invest your money in global index funds that diverse to buy your Investments across thousands of companies from all around the world this of course doesn't eliminate investing risk entirely but it helps to spread your portfolio risk across companies from all around the world instead of just pulling it all into just one asset so with this new perspective I decided to revisit the mass that I did earlier and I realized a huge flaw in the calculations the numbers that we ran went overpaying a mortgage had a massive assumption in them which I didn't even think about at first the calculation spans over 25 years but what's to say that interest rates are going to stay at six percent for that entire 25-year period if inflation eventually does decrease it seems likely that the bank of England are going to start to reduce the bank rate so mortgage rates are going to start to fall and hopefully get closer to the 3.5 value that we saw at the beginning of the year but then again this could actually go either way this data shows the UK average mortgage rate back in the mid 90s and we can see that it was common for rates to exceed six percent with them even breaching eight percent in some cases the truth is that we don't really have an idea of where mortgage rates are going to go in the future but it seems pretty soon ability to assume that we're just going to stay at six percent for the next 25 years and there are more assumptions that we have to address because for Vanguard investing returns forecasts that we looked at was created back in May back when the bank rate was set at one percent but it's now at 2.25 and it's expected to go higher and if we go back to the very foundations of investing it's hard to ignore one of the most famous models that's out there known as cap M or the capital asset pricing model this basically explains that the investing risk that you take on is directly proportional to the expected return of that investment but there is something known as the risk-free rate which is a return that you can expect from an investment that carries zero risk this is normally based on the return of a long-term Government Bond and the UK 10-year Government Bond currently has a yield of around 3.5 to 4 but you could argue that the five percent interest rate that we're seeing in some savings accounts right now could be classed as a risk-free rate so when we are investing this would mean that we'd have a minimum expected return of five percent but if you were to invest in a diversified Equity portfolio then your expected return would be pushing up closer to the 10 mark this would mean that investing would smash the effective rate of return of six percent that you'd get when overpaying your mortgage but you have to remember that this is all based off of a model and all models have assumptions the main downfall of capm is that it relies on markets being efficient and that doesn't always prove to be true and of course we're talking about expected returns here and that is a completely different beast from the actual investing returns that you're going to see year to year which can be so uncertain now I'm finding it hard to pick a winner so I decided to take a rest watch on TV and recollect my thoughts but I am resigning as leader of the conservative party I pledge that I will serve you with integrity and humility here we go he says sure thing now it's hard to keep up things are changing so fast in our politics and our economy that the numbers related to this decision are literally changing every single day whether you choose to invest or overpay your mortgage with possibilities on how your finances will end up are pretty much infinite and there's no way of knowing whether the decision that you made today will end up being the correct one or not and sadly I have to admit it but one random guy on the internet talking about some average number examples and a few of irrelevant implications is probably not going to be enough to help you make the decision that is right for you the best advice that I can give is to make a decision now based on your own personal circumstances one that you're comfortable with and happy with at this moment in time that doesn't mean that you have to commit 100 to either side why not stay flexible if some factors end up changing which they inevitably will and that makes you want to lean more towards the other side then change your plan for a little bit there's no harm in doing that just try not to waste too much time worrying about whether or not you made the wrong decision because that's going to be a lot of wasted energy and it's going to cause you a lot of stress which defeats the whole point of investing or overpaying your mortgage in the first place but if you're really struggling to make that choice then don't worry because there are far easier decisions that you can make in the meantime that are going to do wonders for your personal finances and that's why you really should watch this video here because I'll show you the different ways that you can profit from the current UK economic crisis to ensure that you are getting the absolute best out of your money in these truly crazy times

Channel: iQinvesting

Views: 206,466

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Id: 7BXiyfccrkg

Length: 11min 2sec (662 seconds)

Published: Sun Nov 13 2022