Does it make sense to overpay mortgage?

Gordon Gekko

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So...

€14k paid off a 30 year 3% mortgage today saves €20k over the lifetime of the mortgage.

A pension contribution of €23k invested 100% in global equities over 30 years could reasonably be expected to grow to €152k. €38k of that could be taken out tax-free (i.e. 25%), leaving €114k in the ARF.

Based on assumptions that aren't unreasonable, which would you prefer...to save €20k over the duration of your mortgage or to have grown your money to €38k in cash plus €114k in your ARF.
 
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Sarenco

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Hi Gordon

If you are going to assume that your pension will grow in line with long-term average equity returns then you should probably also assume that mortgage rates will also revert to their long-term averages over the next 30 years.

I believe the CSO maintains data on representative building society mortgage rates going back to the early 70's. Without reviewing the data, I would guess that the long-term average is probably somewhere around 6 or 7%.
 

Rebelrebel

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So...

€14k paid off a 30 year 3% mortgage today saves €20k over the lifetime of the mortgage.

A pension contribution of €23k invested 100% in global equities over 30 years could reasonably be expected to grow to €152k. €38k of that could be taken out tax-free (i.e. 25%), leaving €114k in the ARF.

Based on assumptions that aren't unreasonable, which would you prefer...to save €20k over the duration of your mortgage or to have grown your money to €38k in cash plus €114k in your ARF.
Hi Gordon,

Would you also include the fact that you will have a term reduction on the mortgage and for those months or years, so you won't have to make that mortgage payment for those final months and years. And you could invest that amount into your pension at that stage also making a return. (Assuming the amount did not exceed the AVC limit - though you could then invest elsewhere)?
 

Gordon Gekko

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Hi Gordon,

Would you also include the fact that you will have a term reduction on the mortgage and for those months or years, so you won't have to make that mortgage payment for those final months and years. And you could invest that amount into your pension at that stage also making a return. (Assuming the amount did not exceed the AVC limit - though you could then invest elsewhere)?
I looked at that, but the term reduction was negligible (circa 9 months).
 

Gordon Gekko

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Hi Gordon

If you are going to assume that your pension will grow in line with long-term average equity returns then you should probably also assume that mortgage rates will also revert to their long-term averages over the next 30 years.

I believe the CSO maintains data on representative building society mortgage rates going back to the early 70's. Without reviewing the data, I would guess that the long-term average is probably somewhere around 6 or 7%.
I don't believe that would be reasonable (and not just because it suits my argument).

Prospective returns should in all probability be circa 7%.

But you would struggle to find anyone who would contend that Irish mortgage rates will be anywhere near their historic averages over the same period.

Long term Irish rates are surely irrelevant now that we're in Euroland in any event?

I guess that my contention would be 7% is reasonable for equity markets over the next 30 years based on current valuations but it is not reasonable for mortgage rates based on any number of factors.
 
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Sarenco

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I don't believe that would be reasonable (and not just because it suits my argument).
Fair enough but you are assuming in your model that the variable rate will remain at 3% over the next 30 years. Does that seem reasonable?

Prospective returns should in all probability be circa 7%.
I certainly wouldn't agree that there is any probability that equity returns are going to average 7% over the next 30 years.

My expectation for the next 30 years is that global equities will, on average, return around 4% over the risk free rate and that mortgage rates will average around 3% over the same rate. No guarantees, obviously, but that's my expectation.
 

Rebelrebel

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I looked at that, but the term reduction was negligible (circa 9 months).
But assuming using your figures on for example a 460k mortgage, Paying off 14k would save you 20k over the lifetime of the mortgage and would also save you 17 months of mortgage repayments (1,939 *17 = 32,963). So in terms of value over the term you would be looking at 53,963.

It still makes the Pension option of higher value using your investment return and mortgage interest rate conditions.

Edited as I realised my mistake!
 

cremeegg

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But assuming using your figures on for example a 460k mortgage, Paying off 14k would save you 20k over the lifetime of the mortgage and would also save you 17 months of mortgage repayments (1,939 *17 = 32,963). So in terms of value over the term you would be looking at 53,963.
Are you not double counting the saving here. The capital repayment is the same the interest is less. The fact the you end up with a shorter term just reflects that you make a capital payment already, and have less interest to pay.
 

Gordon Gekko

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I think that equity returns will remain a function of dividend yield and comapnies' ability to grow their dividend, and that based on the world as things stand that 7% on average over the next 30 years is reasonable.

I believe mortgage rates will fall to 2% and will remain low for a generation because of the sheer volume of debt in the world post financial crisis. I don't think 3% is an unreasonable average.

My views on the above then obviously frame my opinion re pension vs mortgage.
 

cremeegg

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Fair enough but you are assuming in your model that the variable rate will remain at 3% over the next 30 years. Does that seem reasonable?

I certainly wouldn't agree that there is any probability that equity returns are going to average 7% over the next 30 years.

My expectation for the next 30 years is that global equities will, on average, return around 4% over the risk free rate and that mortgage rates will average around 3% over the same rate. No guarantees, obviously, but that's my expectation.
Both Mortgage rates and return on equities should reflect, with many complications and lags, the risk free rate of return.

Mortgages should be the risk free rate plus banks costs and profit.

Returns on equity should be the risk free rate plus the equity risk premium.

Gordon seems to have a cake issue here. To eat low rates on mortgages while having high returns on equities.
 

Rebelrebel

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Are you not double counting the saving here. The capital repayment is the same the interest is less. The fact the you end up with a shorter term just reflects that you make a capital payment already, and have less interest to pay.
I would agree that terms of savings alone you are correct. But I'm thinking more about comparing the value of both strategies at the end of 30 years. Instinctively it would seem to me that you should consider this as this is a monthly amount of 1,939 that you don't have to pay to your mortgage for a period and could use to invest in your pension fund.

I'm completely open to being corrected on this however.
 

Gordon Gekko

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I would agree that terms of savings alone you are correct. But I'm thinking more about comparing the value of both strategies at the end of 30 years. Instinctively it would seem to me that you should consider this as this is a monthly amount of 1,939 that you don't have to pay to your mortgage for a period and could use to invest in your pension fund.

I'm completely open to being corrected on this however.
It's double counting.

Your total interest saving (which is circa €20k) is delivered in the form of the repayments that you end up not making for circa 9 or 10 months.
 

cremeegg

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I would agree that terms of savings alone you are correct. But I'm thinking more about comparing the value of both strategies at the end of 30 years. Instinctively it would seem to me that you should consider this as this is a monthly amount of 1,939 that you don't have to pay to your mortgage for a period and could use to invest in your pension fund.

I'm completely open to being corrected on this however.
It has nothing to do with instinct or personal preference, this is just simple maths.

€14k over payment plus €20k less interest equals €34k. 17 payments of €2k equals €34k

The only saving is the reduced interest approx €20k.
 

Sarenco

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Gordon seems to have a cake issue here. To eat low rates on mortgages while having high returns on equities.
Agreed.

However, even if you assume that the annualised rate of return on global equities will be the same as (or even somewhat lower than) the weighted average mortgage rate over the same period, the pension option still comes out well ahead due to the tax relief.
 

cremeegg

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It's double counting.

Your total interest saving (which is €20k) is delivered in the form of repayments you don't make for circa 9 or 10 months.
Don't confuse him. Its 17 months reduction in term, €20k interest and €14k capital already paid.
 

Gordon Gekko

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Both Mortgage rates and return on equities should reflect, with many complications and lags, the risk free rate of return.

Mortgages should be the risk free rate plus banks costs and profit.

Returns on equity should be the risk free rate plus the equity risk premium.

Gordon seems to have a cake issue here. To eat low rates on mortgages while having high returns on equities.
Not in a world where interest rates have to stay low.
 

Rebelrebel

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It has nothing to do with instinct or personal preference, this is just simple maths.

€14k over payment plus €20k less interest equals €34k. 17 payments of €2k equals €34k

The only saving is the reduced interest approx €20k.
Understood - thanks.

Personally one of the attractions of repaying a mortgage early is that the reduced term will free up a lot of cash once the mortgage is repaid.
But understood it's not a saving.
 

Codogly

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The only issue I have with the Pension being the clear winner is that I believe its possible and even likely that have a decent pension pot in years to come might actually work against you in the form of means testing the state pension out from under neat you ...!!!

I've said it before on this site ..." Why did Robin Hood steal from they rich ... because the poor have FA. "

Extremely UNFAIR I grant but very possible IMHO.
 
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