36 years old - should I make extra payments on mortgage?

Shrugselent

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Age: 36
Status: Single, no children.

Annual gross income from employment or profession: € 60,000

Monthly take-home pay: €3,022 (After tax and pension contributions)

Type of employment: Private sector employee.

In general are you:
(b) saving?

Rough estimate of value of home €350,000
Amount outstanding on your mortgage: €225,500
What interest rate are you paying? 2.95% (variable - AIB)

Other borrowings – car loans/personal loans etc: None

Do you pay off your full credit card balance each month? N/A (no credit card)

Savings and investments: Cash: €22,000

Do you have a pension scheme? Yes, through employer. Current value approximately €30,000. I recently increased contributions. I now put in 15% of salary, employer puts in 5% so that's €1,000 contributions per month going forward.

Do you own any investment or other property? No.

Life insurance: Just the reducing balance policy I had to get when taking out the mortgage. As I am single, and I don't have kids or other dependents this policy is only of benefit to the bank really.

What specific question do you have or what issues are of concern to you? Please see below.

Hi I am a long term reader of the Askaboutmoney forums, but this is my first time posting.

I bought a house in 2016. I took out a 31 year mortgage (approximately 29.5 years remaining). When I started the mortgage payment was €1002 per month but it dropped a few months back thanks to the AIB rate change and is currently €961 per month.

My monthly take-home pay is €3,022 (after tax and pension contributions). Of this, I put aside €1,000 to 'pay-myself first' which leaves me €2,022 for monthly expenses (from which the €961 mortgage is paid etc).

My initial goal (which I have almost reached) was to build up a cash-cushion of €25,000 as rainy-day/emergency fund (representing one year of expenses).

My question concerns the next step of my plan. I am thinking that once I have the €25,000 cash cushion that then I should take half of my €1,000 'pay-myself first' money, and start making additional payments of €500 per month against the mortgage.

My thinking:

(1) If I make an additional €500 per month payment then I will pay my mortgage off quicker, i.e. in approximately 16 years (at about age 52) rather than 29 years (at 65 age).
(2) I save on mortgage interest.
(2) The LTV (based on on the value above) should drop below 50% by 2021 which may make it easier for me to re-mortgage at a lower rate sooner / increase my options.
(3) I understand from reading other posts on this forum that when extra payments are made AIB will keep the mortgage term at the original 31 years and simply reduce the monthly payments. So in effect my 'minimum payment' which is currently €961 per month will be recalculated after each extra €500 payment I make. So after about a 13 months or so of those extra payments my 'minimum payment' will be something like €933 per month rather than €961. I like the idea of the minimum payment dropping month by month. I think it would be a good psychological 'win'. Although of course to ensure that I am actual paying an extra €500 per month I will of have to adjust the €500 upward every month to account for the gradual drop in the minimum payment, so that overall I am still paying €1,461 per total month.
(5) I will still be able to save the other half of my 'pay-myself first' money, which should mean that I have €6,000 per annum of additional cash savings to cover unexpected expenses (without touching the emergency fund) and to put towards a sinking fund for car replacement. My car is 12 years old but it is is in very good condition with very low mileage. I bought it used from a family friend so I know the mileage is genuine. I don't anticipate it should give me any trouble in the next few years. As long as the insurance company doesn't refuse to insure it due to age it should easily last me another 5 years.
(6) The cash cushion : €25,000 in total of which €15,000 will be kept in Ulster Bank's Special Interest Deposit Account (0.85%), €4,000 in the Ulster Bank current account (to avoid bank charges I must keep €3,000 minimum, and I use €1,000 as a buffer above that minimum), which leaves €6,000 which I will keep in the AIB current account (from which the mortgage is paid - no AIB fees b/c of the mortgage).
(7) I have large mortgage ebt, and a long repayment term (29 years remaining). While we are paying higher rates in Ireland than other Eurozone countries, the Eurozone rate is still very low. It is very probable that over the next 30 years interest rates will be higher than they are today, and likely sooner than later. It would be best to pay-it down as soon as possible at these lower rates rather than leaving it as a hostage to fortune.
(8) But by the same token, if I don't make the extra payments then I would have extra cash to add to the cash-cushion/emergency fund or to invest.
(9) I can stop making the additional payments if I feel they are squeezing me too much. Howver I won't be able to get them back as cash.

Other Points I have considered, and my thoughts:

(i) Inflation. I would be paying off €500 early. Due to inflation €500 at the current time should be worth a lot more in purchasing power terms than €500 in the future. So in a way the value of the debt is being eroded by inflation anyway. Does it make sense then to take the €500 in 2018, 2019 etc and pay it off the mortgage which otherwise would be paid in 2046, 2047? But against this, if I don't pay it off the mortgage then what do I do with it instead. If I just put it in cash deposit account it will definitely get eaten away by inflation. At least if I put it against the mortgage I am saving 2.95% pa on it. I would need a gross return of 6.02% before tax on dividends to get a 2.95% net of tax return (assuming a 51% tax rate) or a gross deposit rate of rate of 5% to get to net 2.95% (assuming DIRT at 37% and 4% PRSI). So it doesn't seem such a bad use of the money even with inflation.
(ii) Opportunity cost: Invest it all in the stock market? But I already have a pension which is investing in the stock market every month so perhaps that would be too much exposure.
(iii) Opportunity cost: Loss of access. Payments to mortgage are locked away. I can't access them again unless I effectively re-mortgage.
(iv) Opportunity cost: If an opportunity arises (say another crash in the value of the stock market) then if I had saved the cash rather than put it into the mortgage then I would have a cash to invest. Against that, human nature being what it is I would probably be just as frightened as everyone else in the market and want to hold on to the cash if there was a crash rather than invest. Or I probably would just not wait and invest it rather than holding out trying to time the market.

QUESTIONS:

So that's where my thinking is at. I would welcome a second opinion. What's your view?
(a) Is my cash-cushion/rainy-day/emergency fund of €25,000 reasonable?
(b) Assuming it is, where would you put the €25,000 to earn the best return (on cash)? (Note: the purpose of the €25,000 is an emergency fund so it must be reasonably liquid, and can't be at risk so I don't the stock market is an option).
(c) What would you suggest I do with the other €500 per month which I will be able to save going forward? Just keep it as cash or use it to invest? If invest, in what? (I had originally intended on using the €500 to buy units in an S&P500 ETF through DeGiro, no fees, CGT treatment, a buy-and-hold strategy. Unfortunately I can't do that now because of that change in EU regulations. I don't like UCITS funds because the tax treatment seems too unfavourable to make the market risk worthwhile.)
(d) Do you think I am doing the right thing in making extra payments against the mortgage? The current 2.95% is a relatively low rate of interest on borrowings. Should I just save/invest the full €1,000 of 'pay-myself' monies elsewhere and hope I get a better return? The advantage would be that I should still have access to those funds if they were (say) invested in the stock market, and the return should/could be higher. The disadvantages is that returns could be negative , and even if they were positive I would have to pay tax on the returns (lowering the effective rate of return).
(e) Am I being silly? Life is short and the future is promised to no man. Should I just spend the extra €500 a month on having fun and live it up a little?
(f) Any other thoughts?

Thoughts and suggestions please. Thanks for your time.

Shrugselent
 
I think you've very comprehensively answered most of your own questions.

You're maxing your pension contributions, so overpayments to mortgage are the right thing to do with excess cash.

25k sounds more than adequate as an emergency fund. If you think about it that's 8 months take home pay - for a single person that's loads. I wouldn't be bothering saving much more. Live a little.

Don't be thinking about investing. Your pension should be heavily weighted to equities. Outside a pension it's not tax efficient, and you'd need a high return to beat paying off your mortgage instead.

In terms of deposit returns, regular savings accounts might have best rate for demand deposit - something like BoI mortgage saver, but there is a max balance of about 15k that earns the high rate. There are best buys in the deposit forum.

Re car (we've a few old cars in the family) I'd suggest looking at Aviva next renewal. They will insure cars over 15 years old without loading premium, but only for existing customers.

Best of luck.
 
You have a mortgage of 3.75 times your salary which is huge. This is the greatest source of risk to you. Interest rates will rise at some stage. Your salary may reduce. While the LTV is only 65%, I would not be comfortable with this level of debt.

Here is what I would do:

1) Make sure that you don't let savings and money rule your life. You are single and have a good income. Get the balance right between financial prudence and enjoying yourself.

2) Switch lender. Probably to Ulster Bank. Why pay 2.95% when you could be paying 2.3%. Check out the Best Buys

3) Stop contributing to your pension until you get the mortgage down to a very comfortable level. Or make the minimum required to maximise your employer contribution. When you get the mortgage down to that level, you can then resume your pension payments.

4) Unless there is a risk to your employment, your cash buffer is too high. €10k should be absolutely plenty, but increase it when you know that you will need a new car. Don't worry if your car suddenly dies on you and you can't buy it for cash. The bank or Credit Union will lend you the money and you can pay it off fairly quickly.

5) Shop around for your mortgage protection insurance. People often take it out when they get their mortgage and never look at it again. It might well be cheaper through one of the discount brokers like LABrokers.

6) Definitely forget about investing. You should not borrow money at 2.95% to invest in equities. You will not be able to get a risk-free, tax-free return of 2.95% anywhere.
 
I don't think that inflation at the current levels is relevant to any decision you make. It will happen anyway, irrespective of where you put your money.

You can get a guaranteed tax-free return of 2.95%, so that is the best place to "invest" your money. That is a real return over the rate of inflation which is what you want.

If you have paid off your mortgage and have unborrowed cash to invest, then inflation might be a consideration.

But the key question facing you then will be: Where can I get the best return on my money?

If the following set of circumstances arise, then you might review your strategy:
  • Interest rates remain low or fall and this is expected to continue
  • Inflation is expected to far exceed your mortgage rate
  • The rate of returns on the stockmarket are expected to exceed the mortgage rate
I don't think that this will happen as the first two are related.

Brendan
 
I think a 25K buffer is excellent. As is contributing to a pension. And overpaying the mortgage is good. Only thing missing is living a little. I don't think you're over exposed on your mortgage as the equity is 35%.

And I wouldn't be worrying about what inflation might be like in the 2040's ! Instead think about what will keep you employed for the next couple of decades. More education or retraining perhaps.
 
Hi Brendan,

I’m not convinced that it’s better to pay down one’s mortgage at the expense of pension funding.

Take the example of a 39 year old who puts €23,000 into his pension fund during 2018. Instead, he could pay €13,800 off his mortgage (i.e. 60% of €23,000).

Assuming an average annual return of 4.5% to retirement at age 65, that €23,000 will have grown to €73,140.

The problem with personal pension contributions / AVCs is that it’s very much a case of “use it or lose it”; one can’t back-fund for missed years.

Gordon
 
Hi Gordon

The OP is facing a high level of risk with such a high mortgage. He gets certainty and flexibility by paying it down now.

If we make a lot of assumptions about the next 50 years, the pension might be better. But he is 36. When he retires in 30 years, so many things may have changed. For example, it's very likely that anyone with a private pension will not get the contributory pension as it will be means tested. The private pension may well be taxed heavily at that stage. And, of course, the return may not be 4.5% net of charges.

Don't get me wrong. I am a great believer in pensions. But I would prefer a more comfortable mortgage first.

Brendan
 
it's very likely that anyone with a private pension will not get the contributory pension as it will be means tested
That's certainly a possibility but I disagree that it's "very likely". Also, I disagree that an LTI of 3.75% is "huge" for a single person with an above average income and no dependants. It's a bit on the high side alright but not dramatically so.

Using any after-tax cash flow that is not required to fund lifestyle expenses to pay down the mortgage is absolutely the right approach. But not, in my opinion, at the expense of maximising tax relieved pension contributions.
 
The problem with personal pension contributions / AVCs is that it’s very much a case of “use it or lose it”; one can’t back-fund for missed years.

Spot on, it's a regret of mine that my OH did not have a pension for his earlier working life. Losing many valuable years and the money gone.
 
2) Switch lender. Probably to Ulster Bank. Why pay 2.95% when you could be paying 2.3%.
Absolutely. Not sure how strict they are, but UB have a max 3.5 times LTI for switching. OP has enough funds available to reduce balance to this level, so should switch.
 
Not sure how strict they are, but UB have a max 3.5 times LTI for switching.

Which is another reason for prioritising the paying down of your mortgage.

€225,500 is 3.75 times your income

€210,000 is 3.5 times your income

So knocking €15k off your mortgage could result in a significant saving on your whole mortgage.

Brendan
 
The OP is facing a high level of risk with such a high mortgage. He gets certainty and flexibility by paying it down now.

What risk is he facing?

Hi Bronte

1) A rise in interest rates which would make the mortgage unaffordable
2) A fall in his income which would make the mortgage unaffordable
3) A fall in house prices which would increase his LTV which would constrain his ability to move

Brendan
 
He's not only single but he has no children. He didn't say he needed to move. He'd need to lose his job, interest rates to go crazy and be forced to move all at the same time. Plus his house would have to go down in value by 125K. If all that happened he might, just might lose the house. How realisic is such a scenario. And even if it did happen, he's single and has no dependants.

If you think this is a likely scenario I'm very glad to hear it. I'll be able to purchase property at rock bottom and get fantastic interest on my savings. Can't wait.
 
Hi Bronte


He'd need to lose his job, interest rates to go crazy

If either or both of these happens, he might find it difficult to meet his repayments.

High risk does not mean being wiped out. It does not even mean losing the house.

It could mean falling into arrears and having his credit record compromised.


He's not only single but he has no children.

That is a risk I had forgotten about.

Brendan
 
I think Brendan is over doing the risk associated with this mortgage, with a repayment capacity of €1,900 (while maxing his pension contributions), interest rates would have to go over 10% before he would have to reduce his living expenses to pay his mortgage.
 
So knocking €15k off your mortgage could result in a significant saving on your whole mortgage.
As it happens, the OP could (and probably should) pay €15k off his mortgage today, without scaling back his pension contributions.

The likelihood of seeing dramatic interest rate increases without accompanying wage inflation is pretty much zero.
 
The likelihood of seeing dramatic interest rate increases without accompanying wage inflation is pretty much zero.
I'm quite interested in this bit as it has great relevance on how risk is assessed here. Sarenco - do you have any data backing this up in Ireland and across global markets historically?
 
The likelihood of seeing dramatic interest rate increases without accompanying wage inflation is pretty much zero.

Yes, if you are looking at the national figures.

But what happens to the OP could well be different to what happens nationally.

There may well be a cut in his salary. He may lose his job. He might get sick.

I think we, as a nation, have forgotten about risk. But we are in a very dangerous economic environment. We now have €200 bn of national debt. We are facing Brexit. We are facing trade wars. We are facing attacks on our tax regime. And no one knows what will happen when QE is reversed.

The OP thinks it's necessary to have €25k as a cash buffer and others seem to agree with this. So he does see some risk.

In order to buy a house, one must take on a lot of risk. And 3.75 times one's salary is very high risk. Having bought the house, the right strategy is to reduce that risk. For me, that would take priority over excessive pension contributions. I have seen plenty of people in recent years who were in real financial trouble and would love to have had access to their pension funds.

Brendan
 
Interesting thread. In my view, paying off your mortgage early gives you certainty. Certainty that your debt exposure will reduce. It's important to me for example that I am debt free as young as possible. Paying into a pension might give you an after tax return in excess of what you will save on interest costs on your mortgage over time but it is not certain. Also you can only access your pension fund at a time when your cash needs should be at their lowest. If I have an unencumbered property when I retire I can rent out a room or two tax free based on today's rules to assist with additional cash needs I might have. If i am debt free at this time that money will not be reduced by interest costs.
 
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