Does it make sense to overpay mortgage?

Dagny Juel

Registered User
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I have been crunching some numbers lately and have started to question whether it actually makes sense to overpay my mortgage.

An example scenario is as follows:

Overpaying mortgage by €200/month for 22 years would save me roughly €21k (based on online overpayment calculator, 3.3% interest with AIB).

However, paying into my pension €400/month would cost me €204/month. The tax saving over 22 years is almost €52k! And of course I would hope that the pension money being invested would grow as well.

Am I missing something?
 

Rebelrebel

Registered User
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29
If your mortgage was 350k @ 3.3% for 22 years, your monthly repayment amount would be 1,866 euro. If you overpaid by 200 euro a month you would save 21k over the term. But the term would also be reduced by 2 years and 11 months.

So that's 35 months that you would save paying the 1,866 euro. Which makes 65,310 Euro plus the 21k plus the 200 additional Euro you would have for 35 months (7k) so in total it would be worth 93,310 euro. (Versus 400 EURO a month to your pension for 22 years making 105,600 EURO)

So I don't think it is as straightforward as you make out.

Of course you would expect pension growth as well or you could start lumping the money into a pension after you pay off the mortgage early. But there are restrictions on AVC contributions depending on your age bracket to consider as well.

It may make more sense to do a combination of both and adjust over time.

Open to correction on any/all of the above however.
 

Dagny Juel

Registered User
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Thanks for this, interesting perspective. However, I'm not sure if including the savings from reduced term is accurate in this example. You are not actually saving any money; the mortgage amount is fixed, you're just repaying the capital sooner. The only actual saving is the cost of credit, i.e. the interest rate. Whereas the pension tax break is an actual saving.

I think I need to look into this some more!
 

Brendan Burgess

Founder
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38,651
You are making the question too complicated by looking at it over 22 years.

Your question should be - "Should I pay €100 today into my pension or pay the net amount off my mortgage?"

If you can show that you should pay it into your pension, then that is what you should do. You can then review the question after a year and decide if the answer is still correct.

What return will you get on the €100 after expenses? It's very unlikely to be 3.3%. Maybe do the numbers at 2%. Then ask how will it be taxed when you retire? Probably reasonable to assume 25% tax-free and the rest taxed at your marginal rate.

By paying it off your mortgage, there are some other advantages:
  • You may lower your Loan to Value and so get a lower rate overall on your whole mortgage
  • You can effectively access your money whereas a pension scheme locks it up until retirement age
  • If you have a high mortgage, you reduce the risk by paying it down.
So the answer is not clear. If you have a huge mortgage and a well funded pension, you should probably pay down your mortgage. If you have a small mortgage and no pension, you should probably contribute to your pension fund.

It may be helpful to recast the question: Would you borrow money at 3.3% to contribute to a pension fund? I think that most people would not do so.

Of course, if mortgage rates fall, you might well be prepared to borrow at 2% to contribute to a pension fund.

Brendan
 

Rebelrebel

Registered User
Messages
29
Thanks for this, interesting perspective. However, I'm not sure if including the savings from reduced term is accurate in this example. You are not actually saving any money; the mortgage amount is fixed, you're just repaying the capital sooner. The only actual saving is the cost of credit, i.e. the interest rate. Whereas the pension tax break is an actual saving.

I think I need to look into this some more!
Yea that's true enough. If looking purely from a saving perspective then you only save 21k by overpaying the mortgage versus 52k in tax saving - a difference of 31k. But I think it would be a mistake to ignore it completely. By overpaying the mortgage you are saving yourself from making 35 month of Mortgage payments. Though agreed it's not an actual saving.

I suppose I looked at it by looking at the total "value" of both after 22 years - which makes it much less of a difference (ignoring investment gain).

But, it's just a different perspective. Others might look at it differently again.
 

Sarenco

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Personally, I think it would be reasonable to assume that the net, real return on a typical Irish pension fund will not be dramatically different to the weighted average, real interest rate on a variable rate mortgage over a 20-year period.

Given the tax relief on pension contributions and the tax treatment of drawdowns, I take the view that it invariably makes sense to prioritise maxing out pension contributions ahead of paying down a mortgage ahead of schedule out of after-tax income.
 

Gordon Gekko

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I agree; subject to having an emergency cash reserve, I believe in maximising AVCs / pension before overpaying one's mortgage. A pension may also prove easier to access than the liquidity in one's home.
 

LS400

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521
There is also nothing as satisfying, or for that matter reducing life's stress, as getting the deeds of your property years earlier than expected.

Brendan has tried to show me the error of my ways regarding the mistakes I made in paying off my mortgage earlier than planned, but there is less stress in it now should some disaster befall me.

I also think the examples of paying into your pension taking priority over everything else are really only for high earners or those in guaranteed employment, but let's not go there...

When I had a rough patch some years ago, I can guarantee you it wasn't the extra pension over payments that gave me head space, it was 1) the fact I wasn't going to have the mortgage company make me do a merry dance for them, and 2) the Kids wouldn't have to worry about not having a secure place should the worst happen.

Telling the wife, sorry about the house, but we will have a great pension in 20 something years didn't quite cut it for me.

So, unless your well clued in pension talk, have the guaranteed employment scenario, it's thanks but, no thanks. Show me the Deeds.
 
Last edited:

Brendan Burgess

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Dagny

Here is a Key Post on the topic from 2014

Pay down your SVR mortgage before starting a pension, but don't leave it too late

It was done when
  • mortgage rates were higher.
  • House prices were lower so many people were in negative equity
  • People were less confident about the economic outlook

I am guessing that the principles are still the same, so the conclusions are still valid.

One issue today is that the overall stockmarkets may be fully valued. If you have spare cash, it's probably still worth investing in them. But should you be borrowing at 3.5% to invest in today's markets, even if there is good tax relief? Probably not.

I would tend to pay down the mortgage now and contribute to the pension in later years when your pension payments will be a lot lower due to the overpayments now.

Brendan
 

Gordon Gekko

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Hi Brendan,

I'm struggling to make up my own mind on this. I don't overpay my mortgage (3%) and I maximise my own pension contributions (€23,000 per annum). I don't have the spreadsheet to hand, but I'm not convinced that I should divert the €14k (60% of €23k) towards the mortgage.

Gordon
 

Brendan Burgess

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Hi Gordon

There is no right answer.

I think it's clear to overpay your mortgage in the following circumstances:
  • You have a large mortgage relative to your income > 2.5 times
  • You have a high LTV >70%
  • You may be trading up at some stage in the future
  • Your income is uncertain - maybe self-employed or a dodgy employer
  • You are young - so you have plenty of time to make contributions later in life
  • You already have a well funded scheme for your young age
  • You are approaching the €800k funding mark
I am not suggesting that you should not contribute to a pension. I am suggesting that paying down the mortgage is a priority. And doing this now will allow you make higher pension contributions in later years.


The following factors would argue for contributing to a pension instead of paying down your mortgage
  • Your mortgage is very comfortable
  • You have a reliable income e.g. a public servant
  • You are over 40
  • You have a small pension fund
 

Gordon Gekko

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My concern centres around the fact that once a personal contribution is not made for a particular year, the ability to make that contribution is lost forever.
 

Gordon Gekko

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I need to do some work on this, but my sense is that seeking to accelerate the repayment of one's mortgage at the expense of AVCs is excessively prudent.

It should be a simple enough model, albeit based on certain assumptions.

For example, I have 30 years to retirement. It would not be unreasonable to hope that the €23k I invest this year will be worth €184k 30 years (basically compounding at 7% on average).

That's what I may forego by choosing instead to repay an extra €14k a year in relation to a mortgage that will be repaid anyway. And what good is extra "after tax" money to me down the line, when if I invest it, I get hammered for income tax and CGT on any return?
 

Brendan Burgess

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€23k I invest this year will be worth €184k 30 years (basically compounding at 7% on average).
Hi Gordon

It might not be unreasonable to hope for this. But it would be unreasonable to expect it. Do you really expect this return? Which would be at least 8% before all charges?

And even if you get this phenomenal return, you are not forgoing it. When it's paid out to you as pension, it will be subject to tax, in some shape or other.

And what good is extra "after tax" money to me down the line, when if I invest it, I get hammered for income tax and CGT on any return?
I don't fully understand this argument. I am suggesting that if you meet the criteria above, you should prioritise your mortgage over your pension. Over time, you will get older, your mortgage will get more comfortable, your LTV will fall. At that stage, you switch to prioritising your pension over your mortgage repayments.

Brendan
 

Dagny Juel

Registered User
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18
Thanks everyone for your responses, plenty to think about.

I always thought that paying off my mortgage was a priority but as mentioned in the OP, have started to question this now. What insipred this post is this video I saw on youtube. I know that this couple live in the US and have completely different circumstances with college loans etc. but thought that perhaps some of the principles might be the same. Definitely worth watching.

https://youtu.be/CV3FjnKu314
 

Duke of Marmalade

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It may be helpful to recast the question: Would you borrow money at 3.3% to contribute to a pension fund? I think that most people would not do so.

Brendan
Boss sums up the financial aspect of this decision succinctly. Of course, there is the emotional dimension as well which has been well articulated by LS. But I will stick to the financial question thus recast. If the answer is "no" then you should pay down your mortgage but by the same token if the answer is "yes" you should be constantly remortgaging to fund your pension which seems a bit counter intuitive.

There are shades of the great Mortgage Endowment debates which was of course the extreme in delaying paying down your mortgage so as to build up savings in the stockmarket.

The difference here is of course the tax relief on pension contributions and unfortunately there is no one answer.

If you already expect that your pension will put you in the higher income bracket then any additional funding is not really being tax advantaged as the extra USC on your pension will negate the tax free lump sum factor. Of course the rules could change - but this in itself is a negative for pension funding because of its lack of flexibility - will that tax free lump sum anomaly always be there?

So let's say that you are in the position that the tax aspects are pretty neutral the question recasts itself even more starkly. Should you borrow at 3.3% to invest in the stockmarket? IMHO No!
 

Sarenco

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It would not be unreasonable to hope that the €23k I invest this year will be worth €184k 30 years (basically compounding at 7% on average).
Hi Gordon

Unfortunately, I don't think that's a reasonable expectation (assuming you are talking about real (after inflation) returns, net of investment costs).

According to the 2017 Credit Suisse Investment Yearbook, the annualised (gross, real, total) return on a globally diversified portfolio of equities since 1900 was 5.1%.
http://publications.credit-suisse.c...fm?fileid=AE3E00B9-91E2-D1FA-6C18765D3A968D73

However, you really have to look at holding periods of 40+ years to get close to that historical average. Equities are obviously highly volatile and the average return over shorter periods has diverged sharply from the long-run average. For example, the annualised real return on a diversified portfolio of global equities so far this millennium (2000-16) has only been 1.9% (again per Credit Suisse).

Your question should be - "Should I pay €100 today into my pension or pay the net amount off my mortgage?"

What return will you get on the €100 after expenses? It's very unlikely to be 3.3%. Maybe do the numbers at 2%. Then ask how will it be taxed when you retire? Probably reasonable to assume 25% tax-free and the rest taxed at your marginal rate.
Hi Brendan

That still favours the pension option (100@2% over 22 years = 154.6, versus 60@3.3% over 22 years = 122.56).

Bear in mind that in addition to the 25% tax-free lump sum, a married couple are currently exempt from tax on their first €36,000 of income once one spouse reaches 65. That level of income would require a pretty sizeable pension fund.
 

Brendan Burgess

Founder
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Hi Sarenco

It may favour the pension option if the choice is between a pension and a mortgage payment.

But the real choice is:

Pay into a pension now
or
Pay down your mortgage now and make the pension payments later.

For a young person, there will be plenty of time to contribute to the pension in later years.

Brendan
 
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