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

[Gordon Gekko]

I’ve been thinking about this and I remain unconvinced regarding the merits of paying down one’s mortgage at the expense of pension funding.

Also, in an emergency, surely it’s preferable to have (say) €50k in cash and to owe (say) €450k on one’s mortgage rather than having €25k in cash and owing €425k? Having surplus cash is one of the best ways to mitigate risk.

Going back to the mortgage/pension point, if not getting the State Pension is a risk, then that’s an argument for focussing on pension funding. Also, if paying a lump sum off my mortgage today takes one year off it in 30 years time, is that really that attractive? Would I not prefer having €23,000 compounding in my fund for the 30 years? Especially when I’d expect to have more rather than less money then.

And is it that big a deal to have “free” accomodation; the interest cost (or even the interest plus capital cost) of most mortgages is quite a bit less than the equivalent rental cost.

 

[LS400]

There is a burning light within the original question, which trumps all other thoughts imo.. You are in the private sector, and weather you like it or not, your exposed to a heck of a lot more difficulties... Pay down that Mortgage if at all possible and release yourself as early as possible from that debt.

I would answer that question completely differently, were you in the Public sector.
Pump up you pension where possible and live wilder, for there is a lower risk of you facing the risk of you loosing you job which pays your Mortgage.

This is not Private Vs Public, but you cant stick you head in the sand and say it doesn't have a bearing on the above question. It makes a fundamental difference on what strategy you would employ, and the thinking behind it..

 

[Brendan Burgess]

if not getting the State Pension is a risk, then that’s an argument for focussing on pension funding.

This really is a conundrum.

There is no way that the state can continue to pay the very generous contributory pensions at the current level.

So they will have to means test them.

If you have a comfortable pension, or other income, you probably won't get the contributory pension.

It's just a risk worth pointing out.

Again, I would stress that I am a big fan of pensions. But I am a bigger fan of paying down very risky, very high levels of debt today.

Brendan

 

[Brendan Burgess]

Also, in an emergency, surely it’s preferable to have (say) €50k in cash and to owe (say) €450k on one’s mortgage rather than having €25k in cash and owing €425k? Having surplus cash is one of the best ways to mitigate risk.

Yet another conundrum.

The best way to reduce risk is to reduce borrowing, or more correctly, net borrowing.

If I had a mortgage of €450k and cash of €50k and I have just lost my job, I would not pay it off the mortgage. I would use it to fund my mortgage repayments until I get another job.

But the danger of losing his job is not imminent. So the savings from paying down most of the cash reserve are worthwhile, but it's not a clear decision.

If there were a real risk of losing his job in the near future, then he should start accumulating cash.

The cash accumulated + the redundancy payments should sort him out while looking for a job.

I would think that around €5k would be plenty under current circumstances and he should increase this if the risk of a loss of income increases.

Brendan

 

[Sarenco]

So they will have to means test them.

There are plenty of other options available to a future Government to deal with this issue.

For example, they could simply cut the old age pension to UK levels. Or they they make it more difficult to qualify for a full contributory pension. Or they could push up the age at which the pension becomes payable. Or they introduce incentives to encourage retirees to defer taking their pensions to a later age.

Or they could introduce some combination of any of the above.

Trying to means-test what by then will be a very significant proportion of the population would be a political and administrative nightmare.

 

[Shrugselent]

Thanks !

Thank you all for taking the time to read my very very long and rambling post and then share your thoughts. This has been a valuable exercise. You've given me a lot to think about. It's an odd experience to read familiar names commenting on the OP's facts and then realise - that's me! Positive, but a little jarring at the same time!

I think I will need to take some time over the next few weeks to really chew over your thoughts. Particularly those which challenge my own preconceived views.

Thanks for all the ideas, and apologies for not acknowledging/replying to individual comments and suggestions. I have instead shared my initial thoughts on the general themes emerging:

(1) Pension:

I must pay in 5%, and my employer matches that 5%. My additional 10% AVC is not matched. The employer covers the costs of running the pension scheme so 100% of the contributions are invested. The investments (from recollection) are in low cost index-tracking funds (so these should be low fees - but I don't exactly recall if I checked that). I get 40% tax relief on the contribution. If I was to stop the 10% AVC reduce my contributions to just the 5% required by the scheme and matched by my employer than my net take home pay would be €3,323 per month (i.e. €300 more cash per month, €3,600 more cash per annum). However my pension asset would be €6,000 less per annum.

My initial reaction: I would be reluctant to reduce my pension contributions. I will consider this further over the weeks to come, but my gut says no.

(2) Switch:

This is something which I have not really looked into. One of the points that attracted me to AIB was that they seem to be competing on the basis of the lowest variable rate. My concern with switching to a fixed rate with another bank is what would happen after the initial 2 year fixed period ends. I assume I would then go on their standard variable rate at that point unless I fixed again. I'm concerned I could get stuck with a higher rate after the 2 years, and (since I may still have a high loan to income multiple) I might find it difficult at that time to switch back / elsewhere. As such my inclination is to stick with AIB on the basis that it is the devil I know.

Perhaps I have a blindspot here?

(3) Extra Payments:

The consensus seems to be that paying the extra €500 is a good idea. I am going to proceed with that.

I will have to chew over whether to also use the remaining €500 of my €1,000 'pay myself first' money to make extra mortgage payments. I agree that it doesn't make sense to invest it, and that I should have enough of a cash cushion with the €25,000. Also it doesn't seem to make much sense using it for a sinking fund for possible car replacement etc when I already have an emergency fund (it seems improbable that I would need both at the same time).

That just leaves the 'live a little' point. I might make a soft commitment to pay the second €500 against the mortgage but allow myself to use it for fun stuff every 2 or 3 months if the notion strikes me.

(4) Amount and use of emergency fund monies:

I agree that holding €25,000 in cash earning little to nothing in interest (which is then subject to DIRT) while having €225,000 in mortgage debt is inefficient.

Yes, paying €13,000 down against the debt would save on interest and reduce the term (and the minimum compulsory monthly payments would also be reduced which increases security to a degree).

However I draw comfort from the notion of 12 months of expenses. Perhaps I'm still a little traumatised from the last recession. It was a difficult time, and we're at the 10 year anniversary, so it has been fresh in my thoughts.

While I will think on it further, my gut is telling me to hold on to the full €25,000 (at least for the next few years until Brexit plays out). The extra €13,000 in cash (if used just for mortgage) is equivalent to 13.5 months of payments of €961, and there is a lot of security in that.

Perhaps its overkill, but I will sleep easier with the extra cash and there is value in that.

Exercise:

Since Brendan's views are the most challenging, I have set them out below to force me to really consider them.

My understanding of his view is that I should consider:
(1) Using the full €1,000 per month of my 'pay myself first' money against the mortgage. [ + 1,000 pm cash to mortgage] #
(2) Reducing pension contributions to the amount the employer will match (5%) and pay it to mortgage [ + 300 pm cash to mortgage]
(3) Reducing emergency fund to €12,000. [ + 13,000 cash once off to mortgage * ]#
(4) Re-mortgage at lower fixed rate with Ulster Bank. **

#[I reread the forum posts after preparing the calculations below, and I now see Brendan actually suggested I use some of the money to live a little/worklife balance, and suggested 10k buffer rather than 12k but I'm not redoing the calculations now!]

* For the sake of argument I am going to assume my emergency fund is already at 25k (as that is what I will be comparing it against). Not perfectly accurate, but close enough.
** As it is not certain whether I can re-mortgage with UB, nor what would happen after the 2 year fixed period expires, I am going to exclude this option from the calculations below. It's something I need to explore further.

Abbreviations used:

T: Time remaining to fully payoff of the mortgage at this rate of overpaying (currently 29 years if I do nothing).
S: Amount of interest which would be Saved.
EMCR36: Estimated Minimum Compulsory Repayment after 3 years (36 months) of this plan. (i.e. if in 3 years time I can no longer afford/wish to make extra payments, what should my minimum monthly payment with AIB then be (assuming no change in rate).​

Note on calculations. I calculated TR and IS using the Karl's mortgage calculator app. I have confidence in those figures. However I calculated the figures for EMPR36 by fudging the figures in an excel amortization spreadsheet I found online so its possible the EMPR figures may not be entirely correct. For the purpose of the calculations I have assumed there would be no change in interest rates.

Results:

'No Action' [961 + no extra payments per month]

• T:29y S:€0 EMPR36: 961pm

'My initial proposal' [€961 + extra €500 per month.]

• T:16y3m S:€51,099 EMCR36: 949 pm

'My revised proposal' [€961 + extra €1,000 per month.]

• T:11y5m S:€69,178 EMCR36: 866 pm

'Brendan Max' (1) + (2) + (3) above: [€961 + extra €1,300 per month + once off €13,000]

• T:9y1m S:€79,357 EMCR36: 757 pm

'Brendan Reduced-Pension' (1) + (2) above: [€961 + extra €1,300 per month]

• T:9y9m S:€75,367 EMCR36: 817 pm

'Brendan Reduced-Cushion' (1) + (3) above: [€961 + extra €1,000 per month + once off €13,000]

• T:10y8m S:€74,009 EMCR36: 807 pm

Conclusion:

I shall have to ponder on the above. A ten year term is attractive.

However right now my gut is telling me to keep the larger cash sum of €25,000; keep pension as is; pay extra €1,000 into mortgage (perhaps with a break or two for fun); then re-evaluate in a year. The interest expense on €13,000 a year at 2.95% is €383 but I think that's a small price for a little extra peace of mind in the immediate term.

Please share your thoughts or point out if I've blundered. Thanks.

 

[Brendan Burgess]

I get 40% tax relief on the contribution.

But don't forget that when you draw down your pension, you will pay tax on 75% of it.

One of the points that attracted me to AIB was that they seem to be competing on the basis of the lowest variable rate.

A valid point. It's quite likely that AIB will reduce variable rates to compete. They are unique among the lenders in that they pass on rate cuts to existing customers.

But there are some very good deals out there and the likes of Ulster is committed to allowing existing customers avail of the best deals on offer to new customers.

 

[Brendan Burgess]

The interest expense on €13,000 a year at 2.95% is €383 but I think that's a small price for a little extra peace of mind in the immediate term.

And I would have no problem at all with paying this small premium for a short amount of time in a period of uncertainty.

• But it won't be for just a year or so, it will probably be for a few years.
  
• The €13,000 will probably rise.
  
• The interest rate will probably rise.

So, by all means, borrow €25,000 at 2.95% to put it on deposit at 0%, but keep it under review.

Brendan

 

[Sarenco]

But don't forget that when you draw down your pension, you will pay tax on 75% of it.

Let's project forward 30 years and say that @Shrugselent retires with a pension pot of €600k.

He withdraws a lump sum of €150k and uses the balance to buy an annuity of €18k per annum. Under current rules, he won't pay any tax at all on those amounts.

Sure the rules could change in the future but we can only play the game in front of us…

 

[Bronte]

I'm confused about the 75% tax on the pension?

Is this correct:

Take 150K in cash
Remainder of 450K buys a life long annuity of 18K
Plus state pension of ? 10K or so?

 

[Sarenco]

I'm confused about the 75% tax on the pension?

Under current rules you can take 25% of a pension pot as a tax-free lump sum, subject to a cap of €200k.

The first €18k of income is exempt from income tax for an individual aged 65+ (€32 for a married couple once one spouse is 65+).

 

[Brendan Burgess]

Sure the rules could change in the future but we can only play the game in front of us…

Hi Sarenco

He is earning €60k at age 36.
There is a fair chance that he will have other income on retirement.
If he gets the state pension and a private pension - which I admit is unlikely - it will be taxable.

But my overall point is that people say "I get 40% tax relief on my pension contributions." as if it's free money. They must remember that they may pay tax on the way out.

The game in front of us is an uncomfortably high mortgage. I would play that game rather than start training now for a game which I would be playing in 30 years. There will be plenty of time to train for that game after I finish the current game.

Brendan

 

[Gordon Gekko]

Hi Brendan,

For people with wealth, the game isn’t the 40% tax relief because, as you rightly point out, it’s taxable on the way out (albeit on a diluted basis, with the lump sum taxed favourably and no PRSI from age 66).

The game is the gross roll up and tax-free compounding. I fully expect the €23k I lob in this year to be worth somewhere between €70k and €140k in 30 years’ time.

I could pay €13,800 off my mortgage instead, but I’m convinced that pension funding is more advantageous.

Gordon

 

[Sarenco]

There will be plenty of time to train for that game after I finish the current game.

I think that's the key problem with your argument Brendan.

Fundamentally your argument ignores (or at least downplays):

1. the "use it or lose it" nature of the tax relief on pension contributions; and
2. the very significant dispersion of equity returns over shorter holding periods.

There are logical reasons to expect the net return on a well constructed equity portfolio to significantly exceed the weighted average interest rate on a mortgage over the long-term (say, 30 years). Over the shorter term, who knows?

 

[Shrugselent]

Well I'm going to keep this brief today, as I stayed up far too late the last couple of nights and I haven't slept well.

It's been interesting reading all your comments again today. Thanks.

Drum-roll...... I have an announcement! I have just struck a small blow against my mortgage. I have made the first (hopefully of many) extra payment of €1,000 and set up a standing order for that amount going forward. I will continue to also transfer the existing payment level of €961 to the feeder account and then manually sweep the excess across against the mortgage as the minimum payment drops over time with the extra payments.

Brendan has made some thought provoking points about the level of my emergency fund, much of which I must agree with on a rational level (although I'm not quite there emotionally). I will need to reflect on that, and my security/comfort needs. For the moment I have decided to just maintain it at its current level (neither increase nor decrease).

I tend to agree with the other posters on the pension. I think I will be better off in the long run to keep it. So I intend to keep my current rate of contributions. I would go down the rent-a-room route before cutting back on pension. Considering AIB are living in my spare bedroom anyway I may as well give them some company and then I can move 'em both out sooner! Additional monthly rent-a-room income would also make me more relaxed about reducing the emergency fund... so perhaps that may be best way for me to proceed.

Switching is something I will also have to consider a little further. I will probably spend the long weekend playing around with calculators and reading other posts on this forum.

I highly recommend the Karl's Mortgage Calculator app (I have an android phone). Playing around with it has really motivated me to make extra payments. It's also far more versatile then I initially thought and can also calculate how much monthly payments will be reduced by making an extra payment (you have to click on settings to open a menu). While I found it a little cumbersome at first because of all the options, it is worth the effort. It's possible to change how the interest is calculated (i.e. change it to 360 days), and when it compounds (i.e quarterly) so I think I have been able to model the details of my AIB mortgage quite closely. The projection.... based on an extra payment of €1,000 a month, (i.e. to make a total of €1,961 per month) I should be clear of my mortgage in just over 11 years, in or about October 2029.

I don't think I would have started making the extra payments so soon if I hadn't posted on the forum and received all your reassuring feedback. So thanks everyone for your comments and support!

 

[LS400]

A very well balanced reply, fair play to you. And while one size does not fit all for everyone, Im heartened to see you are aiming for an 11-year plan to clear your mortgage. The headspace that it will give you really can't be emphasised.

Its precisely for that reason, I would put a finger to keyboard to encourage mortgage holders to look at making such moves where possible, and in fairness to BB, he tends to simplify the rationale behind it.

 

[RedOnion]

It's possible to change how the interest is calculated (i.e. change it to 360 days), and when it compounds (i.e quarterly)

The calculator is brilliant, but you're getting into far too much detail if you're looking at settings like that! It's nice to understand it fully, but don't be get caught up in getting it 'penny perfect'. If you're comfortable with Excel, you'll be able to make up a very quick model, just assume interest is capitalising every month and use the 'PMT' function to recalculate your repayments for the remaining term. It's not perfect, but it's accurate enough for what you're doing, and gives lot's more flexibility for scenario inputs.