Does it make sense to overpay mortgage?

Gordon Gekko

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Hi Sarenco,

I was thinking in terms of a 7% nominal return (I'm invested 100% in diversified global equities with a 0.45% TER).

Brendan, the issue is the % restriction for personal pension contributions. If someone waits to (say) 50 to commence meaningful contributions, they're restricted to putting €34k a year into the fund. There is no scope to make "catch-up" contributions. Every year one doesn't contribute circa €30k, one is down between €100k and €200k at the end.
 

Sarenco

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

I think the fatal flaw with the argument that somebody should prioritise paying down their mortgage ahead of making pension contributions when they are early in their career is that it ignores the very significant dispersion of equity returns across different time periods.

I would actually be of the view that, all being equal, somebody that is early in their career should prioritise making pension contributions to maximise the possibility of capturing something close to the long-term average return on equities. Conversely, somebody that is later in their career should prioritise paying down their mortgage ahead of schedule to gradually de-risk their position as retirement draws closer and their human capital (present value of future earnings) shrinks.

To put it another way, by holding off making pension contributions while carrying a mortgage, an early career investor is missing an opportunity to "diversify across time" as he is concentrating his bet on the return on equities over a much shorter time period.
 

Brendan Burgess

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Every year one doesn't contribute circa €30k, one is down between €100k and €200k at the end.
Not really. You are assuming that the person will be in a position to make the maximum contributions every year from age 35 to retirement at 65.

If they do that, they are going to exceed the €800k tax-free lump sum limit.

Brendan
 

Brendan Burgess

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I think the fatal flaw with the argument that somebody should prioritise paying down their mortgage ahead of making pension contributions when they are early in their career is that it ignores the very significant dispersion of equity returns across different time periods.
That just doesn't sound right.

There are different risks involved. You are advocating that people borrow money to invest in equities through their pension. The tax reliefs make this worthwhile, but it's risky. I am advocating getting the borrowing down first and then investing in the pensions. I think that the Duke went even further and said, pay off your mortgage in full before contributing to a pension.

I would have thought that contributing over a 25 year period from 40 to 65 was plenty of "diversification over time". Especially as one has dramatically reduced the risk of interest rate rises through paying down the mortgage.

My gut feeling, although I don't know how to demonstrate it, is that a smaller mortgage and a smaller pension fund, is less risky than a bigger mortgage and a bigger pension fund.

Brendan
 
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Gordon Gekko

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Not really. You are assuming that the person will be in a position to make the maximum contributions every year from age 35 to retirement at 65.

If they do that, they are going to exceed the €800k tax-free lump sum limit.

Brendan
€2m is the relevant number Brendan.

25% out by way of lump sum - €200k tax free and €300k taxed at 20%.

€60k tax on €500k is a stellar outcome.
 

Duke of Marmalade

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Let's take the risk arbitrage out of the picture. Let's consider investing the pension fund in risk free cash. Lucky to get 0% after charges. So we borrow at 3.3% to invest at 0%. No way would any tax advantage compensate for that.

So make no mistake anyone who promotes pension funding over mortgage repayment is effectively advising retail investors to borrow to invest in the stockmarket.
My gut feeling, although I don't know how to demonstrate it, is that a smaller mortgage and a smaller pension fund, is less risky than a smaller mortgage and a smaller pension fund.

Brendan
Boss that doesn't sound quite right:rolleyes:
 

qwerty5

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Let's take the risk arbitrage out of the picture. Let's consider investing the pension fund in risk free cash. Lucky to get 0% after charges. So we borrow at 3.3% to invest at 0%. No way would any tax advantage compensate for that.

So make no mistake anyone who promotes pension funding over mortgage repayment is effectively advising retail investors to borrow to invest in the stockmarket.
There's a good chance I'm wrong here.

Suppose I've one year left before pension, and one year left before mortgage.

If I forgo €100 of my take home pay I'll get about €200 invested into my pension. Saving myself €100 assuming no growth or fees. If my pension is low (below €200K from the numbers above) I can take this out tax free or at 20% if I've €500K.
If I take the €100 of my take home pay and pay it off the mortgage I'll save €3 assuming I'm on a 3% mortgage.

Am I totally off the wall there. It is possible / likely.
 

Sarenco

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@Duke of Marmalade

Would you advise a 30-year old with a mortgage on a tracker rate of ECB+1% to prioritise paying down their mortgage ahead of contributing to a pension?

Or what if the mortgage rate was fixed for 30 years @3.5%?

I'm trying to tease out whether you have a principled objection to investing in a pension while carrying mortgage debt or whether your opinion is based on your expectations of future investment returns or interest rates over a particular timeframe.
 

Gordon Gekko

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Let's take the risk arbitrage out of the picture. Let's consider investing the pension fund in risk free cash. Lucky to get 0% after charges. So we borrow at 3.3% to invest at 0%. No way would any tax advantage compensate for that.

So make no mistake anyone who promotes pension funding over mortgage repayment is effectively advising retail investors to borrow to invest in the stockmarket.
Boss that doesn't sound quite right:rolleyes:
Is it not key that €100 goes into the pension to compound tax-free, whereas only €60 is paid off the mortgage?

Also, with regard to the leverage point, I don't believe it's particularly reckless to borrow at 3% to invest 100% in equities into a tax free environment over 30+ years.
 
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Brendan Burgess

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Suppose I've one year left before pension, and one year left before mortgage.
This overall debate is about funding a pension or paying down a pension much earlier.

Close to retirement, especially a year to go, when the tax benefits are much clearer, it will be clear whether contributing to a pension is better or not. In the case you outline, with a small pension fund, maxing the pension contribution is the right idea.

Brendan
 

Duke of Marmalade

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Is it not key that €100 goes into the pension to compound tax-free, whereas only €60 is paid off the mortgage?

Also, with regard to the leverage point, I don't believe it's particularly reckless to borrow at 3% to invest 100% in equities into a tax free environment over 30+ years.
There are two points here,
Comparing risk free alternatives at today's interest rates there is no compounding at play in the pension fund.
On whether taking the investment risk on a tax free basis makes sense is debatable, you seem to think yes, I'm not so sure.
 

Gordon Gekko

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But where's the logic in only looking at risk free alternatives? The choice is not limited to those two options.
 

Gordon Gekko

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Surely this is simple enough to model? I'll take a look tomorrow.

Take someone whose mortgage is at 3% with 30 years left on it. He's 35, with 30 years to go to retirement. He has a choice this year, invest €23k in his pension, or repay €14k of his mortgage.

I don't believe that it's unrealistic to assume an average annual nominal return 6.5% over a 30 year period from an all equity investment strategy (with a TER of, say, 0.5%).

What does that look like in terms of wealth creation vs early repayment of the mortgage and subsequent investment of the mortgage repayments that don't arise on foot of its early repayment?
 

Sarenco

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Surely this is simple enough to model?
Hah! If only.

What assumptions are you going to use for future mortgage rates? What about the sequence of returns on your equity investment? I assume you don't expect to achieve a constant annual return of 6.5% over the next 30 years.

Don't get me wrong - I would still recommend to somebody in their 30s to prioritise making pension contributions over paying down their variable rate mortgage.

However, Duke is absolutely correct when he suggests that recommendation implies taking a degree of investment risk and the market obviously has absolutely no obligation to meet my expectations - over any timeframe.

It's a judgment call.
 

Gordon Gekko

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It most certainly is.

But isn't sequencing of returns irrelevant when no drawdowns are occurring and contributions are regular and consistent?

I absolutely agree re the market, however 30 years is a meaningful time horizon, and one where it is not unreasonable to expect returns in or around the long term averages.
 

Sarenco

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No, the sequence of returns matters where there are contributions to or drawdowns from a portfolio.

Bear in mind that the first euro you contribute will be invested for a lot longer than the last euro you contribute. Also, I think it makes sense to think in terms of your "euro weighted" time horizon.
 

Gordon Gekko

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No, the sequence of returns matters where there are contributions to or drawdowns from a portfolio.

Bear in mind that the first euro you contribute will be invested for a lot longer than the last euro you contribute. Also, I think it makes sense to think in terms of your "euro weighted" time horizon.
But isn't it fair to say that the longer the time horizon, the more likely the investor is to achieve long term averages? And that 30 years is "getting there" in terms of a time horizon?
 

Sarenco

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But isn't it fair to say that the longer the time horizon, the more likely the investor is to achieve long term averages? And that 30 years is "getting there" in terms of a time horizon?
Yes, historically that's certainly been the case.
 
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