Better to save than to overpay a low fixed rate mortgage in some instances?

[skrooge]

A recent post got me thinking are we close to the point where it makes financial sense to save rather than to pay down debt i.e., for some borrowers the return on savings (net of DIRT & PRSI) is greater than overpaying a fixed rate mortgage.

There was a point in the past where this strategy made sense for tracker mortgages.

https://www.askaboutmoney.com/threads/should-i-overpay-my-tracker-mortgage.187499/

At the start of the 2022 both Avant and ICS were offering various fixed terms at 1.95%. I think the best rate on the market was a green mortgage from BOI (I think) @ 1.9%. With DIRT @ 33% a deposit rate in the order of 2.83% (BOI green) or 2.92% (Avant/ICS) would seem to be the tipping point whereby some people could be better off switching from overpaying to saving. Factor in PRSI and the same rates increase to been 3.0% & 3.1%.

To put those rates into context a quick look on raisin suggests a 5 year fixed rate could earn you as much as 3.45% gross on your savings.

The above is not completely risk free:

• Deposit rates may be fixed when you take it the savings product but DIRT and PRSI are not. You would only know when interest was paid what your effective after-tax deposit rate actually was. This is less of an issue for shorter term deposits e.g., Thanks to the budget I know what DIRT should be on fixed deposits maturing in 2023. 2024 onwards is less certain.
• You have to ask why are the deposit rates on offer so high? Remember  only the first €100K of savings are protected by deposit guarantee schemes.
• It might make sense to pick a deposit term less then the duration of your fixed mortgage as future variable/fixed mortgage rates may be higher. No point making marginal gains in say year 1 and 2 if after you turn refix you've locked into a net loss in year 3 and 4.
• Movement in interbank rates might mean any marginal gain from the above might swallowed up by changes in break fee.
• What is the ultimate plan for your savings? I've assumed it's eventually to pay down the mortgage debt. If you're tempted to spend the money elsewhere it might be advisable to just focus on paying off the mortgage.

 

[ClubMan]

Does the fact that any mortgage overpayment is buying you something tangible (equity in the property) need to be considered?

As ever, mortgage protection life insurance costs (and optional repayment protection insurance if relevant) might need to be also factored into any calculations. But they may be marginal in many cases.

 

[Brendan Burgess]

Does the fact that any mortgage overpayment is buying you something tangible (equity in the property) need to be considered?

No, that is not a consideration.

You own the house anyway, whether you have a small mortgage or a big mortgage backed up by savings.

Brendan

 

[Itchy]

Does the fact that any mortgage overpayment is buying you something tangible (equity in the property) need to be considered?

I suppose with any investment you retain an option to purchase the equity in your home with an opportunity cost equal to the net return on the investment less your interest rate.

 

[noelÓm]

The logic of minimising monthly repayments on a low interest rate mortgage makes a lot more sense in countries with very long-term fixed periods, like the United States where 30-year fixations are common. You can save the extra money in a deposit account at a higher rate as you say, invest in a pension, or invest in some other asset.

There’s another possible benefit in that the principal on your mortgage is fixed, but your income and wealth might rise over time with inflation. So, you might want to take the bet that inflation will ease your debt burden over time and that you can ride out the higher interest rates that might accompany the inflation. The downside is that house prices might also fall, pushing you into negative equity and making it hard to move or refinance. Those price declines might also come at the same time as your income falls or your employment becomes more precarious.

A major complexity for your strategy is that the vast majority of fixed rate periods in Ireland are less than 7 years. Avant and Finance Ireland have/had niche products with up to 30-year terms, but those are really exceptional cases. So the moment your fixed rate period is up, you are exposed to market pricing again. For most people with fixed rates, this will be somewhere between 0-5 years away.

Even the advice in this country to never give up a tracker rate was predicated on abnormally low ECB rates continuing indefinitely. That strategy is now coming unstuck for many people and their repayment burdens are rising swiftly. The length of time they enjoyed those low tracker rates was pure luck. The risk of higher rates coming back was always there.

Given the way the market looks in Ireland, I think the best strategy for mortgage borrowers will depend on how far you are into your mortgage term. If you expect your LTV to still be quite high when you come off your fixed rate, then you could potentially see your monthly repayment jump by an awful lot. You are obviously also much more exposed to negative equity risk. So, the downside risk is much higher when you are early into your mortgage term. If you are a fair way into your mortgage term and are comfortable that you can ride out price declines or serious interest rate rises, then minimising your repayments and investing elsewhere isn't a terrible strategy given historical precedent. But it comes down to risk appetite ultimately. Overpaying off the mortgage being the safe bet and allocating funds to another purpose the more risky one.

 

[skrooge]

The logic of minimising monthly repayments on a low interest rate mortgage makes a lot more sense in countries with very long-term fixed periods, like the United States where 30-year fixations are common. You can save the extra money in a deposit account at a higher rate as you say, invest in a pension, or invest in some other asset.

There’s another possible benefit in that the principal on your mortgage is fixed, but your income and wealth might rise over time with inflation. So, you might want to take the bet that inflation will ease your debt burden over time and that you can ride out the higher interest rates that might accompany the inflation. The downside is that house prices might also fall, pushing you into negative equity and making it hard to move or refinance. Those price declines might also come at the same time as your income falls or your employment becomes more precarious.

A major complexity for your strategy is that the vast majority of fixed rate periods in Ireland are less than 7 years. Avant and Finance Ireland have/had niche products with up to 30-year terms, but those are really exceptional cases. So the moment your fixed rate period is up, you are exposed to market pricing again. For most people with fixed rates, this will be somewhere between 0-5 years away.

Even the advice in this country to never give up a tracker rate was predicated on abnormally low ECB rates continuing indefinitely. That strategy is now coming unstuck for many people and their repayment burdens are rising swiftly. The length of time they enjoyed those low tracker rates was pure luck. The risk of higher rates coming back was always there.

Given the way the market looks in Ireland, I think the best strategy for mortgage borrowers will depend on how far you are into your mortgage term. If you expect your LTV to still be quite high when you come off your fixed rate, then you could potentially see your monthly repayment jump by an awful lot. You are obviously also much more exposed to negative equity risk. So, the downside risk is much higher when you are early into your mortgage term. If you are a fair way into your mortgage term and are comfortable that you can ride out price declines or serious interest rate rises, then minimising your repayments and investing elsewhere isn't a terrible strategy given historical precedent. But it comes down to risk appetite ultimately. Overpaying off the mortgage being the safe bet and allocating funds to another purpose the more risky one.

Paying down debt is never a bad option it's just potentially in this case it's the second best option.

Yes on the US the potential for bigger benefits given the longer fixed terms but it's scalable to the shorter fixed terms in Ireland.


I deliberately went with the lowest rates I could remember at the start of the year. These will be the first mortgages to face this potential dilemma. There is a possible argument to focus on paying the mortgage to reduce the LTV but in practice are the difference between LTV rates sufficient to offset the general increase in mortgage rates that have happened (with non banks at least)? For some providers (banks), yes because they haven't moved rates. These are also the providers who had higher rates to begin with so the whole argument of saving might not apply anyway (yet?).

The question is am I better off overpaying. Negative equity is an interesting one. Would I rather have all my money tied up in one property when savings rates are sufficiently higher than my mortgage rate? If I'm not planning on moving then I should do what's financial best. In that case at the end of my savings term I should be a little wealthier in a net sense if I've saved at a higher rate.

What if I'm in negative equity and want to move? Would having a slightly better net position but more wealth in cash not be a positive? Whatever about the property in negative equity you will still need liquid assets as a deposit. If anything -and again assuming the interest rate differential is sufficiently wide - you're in a better bet financial position and a better liquidity position.

Ltv aside I don't think the remaining term of the mortgage makes much difference to the argument - unless you're very near the end of the mortgage. Ultimately if I don't overpay and save today and have more money tomorrow on a net basis is that not sufficient to do it.

 

[Brendan Burgess]

Guys

skrooge has raised a very interesting point here.

Should you pay off your mortgage with money that you can put on deposit at a higher rate?

This is very specific.

The options are
A) pay down your mortgage - as most of us advise on Askaboutmoney
B) Hold onto the cash if you can get a deposit rate higher than the mortgage rate

We don't need another thread on the wonders of equity investing. If you think we do, then start a new thread.

Brendan

 

[nest egg]

...Should you pay off your mortgage with money that you can put on deposit at a higher rate?

Objectively, if you can get a guaranteed return, after tax, at a higher rate than your mortgage, then the answer is no.
This approach has the added benefit of not tying up the cash.

The next question is, can you really get a guaranteed return, after tax, greater than your mortgage rate?

 

[nest egg]

I have a particular interest (pardon the pun) in this - I'm about to pay off €20k from my mortgage, which is fixed at 1.95%. Doing so will yield €390.

Alternatively, the best 1 year savings rate I could get on the money, according to Raisin.ie, is 2.9%. This would yield €580. Accounting for DIRT, the net yield would be €388.60

So I'll be €1.40 worse off, I also have the hassle of setting up the savings account, and the hassle of paying DIRT. So not this year. However there may come a time where it is worth the hassle. I'll evaluate that ahead of next year's overpayment, and so on, and so forth.

 

[Merowig]

Objectively, if you can get a guaranteed return, after tax, at a higher rate than your mortgage, then the answer is no.
This approach has the added benefit of not tying up the cash.

The next question is, can you really get a guaranteed return, after tax, greater than your mortgage rate?

Not with an Irish bank https://www.independent.ie/business...me-of-the-worst-rates-in-europe-42162700.html

Savings Accounts - Your Search

Provide your details to start your savings account comparison. Compare your results and find the best savings account for you.

www.bonkers.ie

but if you look abroad https://www.raisin.ie/savings-accounts/high-yield-savings-account/

 

[Brendan Burgess]

This is a very interesting point.

People have raised a lot of issues such as negative equity, inflation and the outlook for house prices, which I think are irrelevant to the decision - assuming the decision is made correctly.

The term of the fixed rate mortgage and the term of the fixed rate deposit are very relevant.

Let's leave aside DIRT and USC to simplify the argument. They can be factored in later.
Let's assume €100k or less so the risk of default does not come into it.

If I have a mortgage fixed at 2% with 5 years to go and I can put money in a demand account earning 2% or more, I should leave the money on deposit. Not only will I earn more, but I will also have access to the money as an earlier poster has pointed out.

If I can't get a demand account, but can put it on deposit earning 2% or more for a term less than 5 years, I should do it.

But say I have to leave it on deposit for 10 years, then it would not be the right thing to do. The mortgage rate may be a lot higher when the 5 year fixed rate is up.

So, does the following capture it

If the term of the deposit is less than the remaining fixed rate period
and
If the deposit rate after taxes is higher than mortgage rate
and
if the amount on deposit is covered by the Deposit guarantee scheme

Then, leaving the money on deposit is better than paying down the mortgage.

(Of course, it may be better to contribute to a pension or invest in shares, but that is a separate thread.)

Brendan