What you should consider first before overpaying your mortgage

Young homeowners with extra cash leftover each month may be better off investing it in their pension rather than overpaying their mortgage, new figures suggest.

Thousands of families will face remortgaging at much steeper costs this year as interest rates climb. But rushing to overpay mortgage bills may not be the most efficient way to invest money in the long-term, research from Interactive Investor has shown.

Its calculations show that someone with a mortgage of £200,000 at 5pc would likely be better off putting their extra cash into a pension.

Myron Jobson, of the broker, said that while many homeowners were “itching” for the day that their mortgage was paid off, pension benefits were hard to match.

He said: “There is no denying the value of delayed gratification that additional pension contributions could offer. The potential of healthy investment returns from a pension over the long term, plus tax relief, could put you in good stead when you reach retirement. Also, some of that uplift could be used to pay off the mortgage if it hasn’t been paid off before then.”

All pension contributions benefit from tax relief from the Government in line with a saver's marginal income rate, which means a minimum of a 20pc uplift.

If someone with a £200,000 mortgage on a 5pc rate and a 20-year term overpaid their bills by £200 a month, their debt would be paid off four years early, Interactive Investor found. Diverting their usual monthly mortgage payments of £1,520 per month, plus 20pc tax relief, into a pension over those four years would result in £100,728 in additional investment after 20 years, assuming a 5pc investment return, the broker said.

However, if they instead chose to invest the extra £200 a month into their pension straight away, it would result in extra pension wealth of £102,758 – a difference of more than £2,000.

Alice Guy, of Interactive Investor, said: “In general, if investment growth is higher than interest rates then we will be better off paying into our pension first, giving our investments longer to grow.”

She said that as interest rates climbed, older homeowners with less time to grow their money may be better off prioritising their mortgage payments, adding: “If interest rates are higher than investment growth then we could be better off paying down our mortgage first. We’ll save more on interest than we gain in investment growth.”

Mr Jobson said that the suitability of each option was “not just a numbers game”.

He said: “There is value in the ‘peace of mind’ aspect of lowering mortgage expenses and not having to be beholden to investment performance. Paying off your mortgage early could give you financial freedom earlier.

“Both options can make you richer in the long run, but it is important to consider your personal appetite for investment risk and time horizon. There are also often earlier repayment penalties for paying off a fixed rate deal, so you need to check the terms of your mortgage deal.”