Don’t rush to pay off your mortgage

Homeowners overpaying their mortgages are missing opportunities to turn their debts into profit centres, says EveryInvestor.

For while paying off high-interest short-term debt like credit cards and overdrafts makes sense, the same logic does not apply to mortgages.

Says Chris Gilchrist of EveryInvestor: “Back in the 1980s homeowners who had used interest-only mortgages and endowment policies ended up with surpluses of 20% or more after paying off their loans. On the basis of average stockmarket performance over a 25-year term, today’s borrowers can expect to do as well or better using a low-cost self-select ISA as their savings plan.”

While low-cost endowment mortgages have created shortfalls for millions of borrowers, this was for two reasons that do not in any way undermine the concept of running a savings plan alongside an interest-only mortgage: endowment policy premiums were set too low, and borrowers were not advised to review their arrangements when interest rates changed.

Using a simple calculation, EveryInvestor shows how borrowers can easily work out how much they need to save each month and can then be confident that over a 25-year period, their stockmarket savings plan will generate a surplus as compared with a capital-and-interest mortgage.

Provided borrowers save at least the amount that would be required to repay their loan at their current mortgage rate, the likelihood is that they will achieve a significant surplus at maturity. An average premium of 2% a year on savings over borrowings would generate a £36,000 surplus on a £100,000 mortgage. A 5% premium (achieved over 15-year periods ending in the 1990s) would create a surplus of £122,000.

Says Gilchrist: “Most people remain unaware of the power of compound interest. Making monthly savings into simple stockmarket plans such as tracker funds over long periods like 20 or 25 years is virtually guaranteed to generate wealth on the basis of all the historical data. Putting such a plan alongside an interest-only mortgage is one of the simplest and most effective long-term savings strategies.”

He adds: “Most borrowers will not intuitively understand the principle that when interest rates fall, capital repayments on a capital-and-interest mortgage are accelerated and vice versa. This is why it is essential to review the combination of an interest-only mortgage and savings plan at regular intervals.”