When you are thinking about when to pay off your mortgage.
There are a range of scenarios which may lead to you being in this position, here are a few:
You have excess income over expenditure and can accelerate your mortgage repayments to chop years off the original term of the mortgage.
You have an unexpected lump sum, maybe from an Inheritance or a Redundancy and can clear the mortgage.
You’ve sold a business or cashed in a share option scheme.
You are retiring and have a tax-free lump sum coming from a pension.
You may also be in the position where you can pay off a chunk of mortgage rather than all of it.
Here’s the rub, it doesn’t really matter what position you are in, or how you have arrived at this position, the considerations which will lead you to decide whether to pay down your mortgage, either in part or in full, will be the same.
The considerations are basically these: is it a good financial idea and how will you feel if you do or you don’t?
Dealing with these in reverse order, the first consideration may be somewhat surprising. How you feel about your financial and wider position is incredibly important.
Even if there is a financial argument in favour of NOT paying down your mortgage, it may just make you feel better to do so. And that feeling can be more influential than some form of monetary calculation that tells you it is a ‘bad idea’’.
Money is nothing in some respects, no more than a ledger item or a means to an end. In and of itself, it has limited importance. Your well-being, happiness and peace of mind, conversely, are all crucial.
So, if paying down your mortgage works for you, simply on this basis, it has merit.
However, the financial position may also matter to you, you may well want to follow whatever you can see is the “best” route forward and you are interested in maximising your long-term financial outcomes and you don’t want to use any excess funds to clear your mortgage if there is a better way of utilising the money available.
In this instance you will need to start making some future projections and assessing the position in its entirety. This is not a straightforward assessment, far from it.
For example, if you have £50,000 still to pay on your mortgage and 8 years to the end of the term, you could make a comparison between the savings you make every month if you clear the mortgage now and how much the £50,000 would generate if you invested it.
That doesn’t work as a comparison, because it is not like for like. For example, if you save paying £800 per month for the next 8 years, once you have spent £50,000 clearing your mortgage, how much does that £800 really save you? If you were paying your mortgage from taxed income, you may need to earn £1,200 per month to earn £800 (after tax). So, does your mortgage save you £800 or £1,200 per month? It depends.
If you can manage your income though a reduction in salary (you are a business owner who controls your own salary, you semi-retire and reduce your income, you pay more money into a pension and reduce your overall taxable income) it is possible to effectively save £1,200 per month even though your mortgage payments are only actually £800. In other cases where you have no control over your salary level, the figure probably sticks at £800.
Let’s say you do save £800 per month, over the next 8 years, and you decide to use your £50,000 to pay off your mortgage then you don’t pay £800 x 12 x 8 a total of £76,800. A lot more than £50,000, however if you keep the £50,000 intact you need an investment return of around 5.5% per year to match this.
However, you will probably need to take investment risk to generate even a 5.5% yearly return, and you may get more or less. If less, then you have worsened your position. You may even lose money if you take risk. Paying off your mortgage is risk free, in investing terms.
You might feel you can invest and get a much higher return; in which case you are leveraging the money to better effect.
You can compare one pathway with the other and try and work out a level position, for example the 5.5% figure, but even this is not a fair comparison, because the £800 you save each month could be invested and you could get a return on each £800 saved so over 8 years the effective total figure is higher.
The risk factor cannot be priced accurately, nor can the bird in the hand aspect. Once your mortgage is paid off it may be difficult, or expensive, or even impossible, to refinance afresh at a later stage.
You may want to keep your cash balances fairly high as you have a child who may need your help in a few years or a Business which may need some financing.
Again, there is no accurate way of putting a price onto this factor.
The point is that in all these situations, the question of whether to pay off a mortgage, whether it is a good or bad idea is always circumstantial. Plus, it is always a multi-faceted view that needs to be taken to make the judgement call. That view will often incorporate how you feel about your finances, what helps you to sleep at night (and what doesn’t) and then and only then can an informed decision be made.
This is where an independent financial adviser can make a big difference because we have the experience to run through this with you, look at all the figures, the future projected pathways and talk with you about how your future plan might look under different scenarios.