Key Post Compounding doesn't just work on pensions - it also works on mortgage overpayments!

jasdpace@gmail. said:
So you are assuming that the earnings cap miraculously disappears?
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I missed that completely. I suppose if we take the 3% salary escalation to be inflation and the earnings cap increases with inflation the spreadsheet stacks up. But then it assumes the pension fund threshold stays fixed which is a tad inconsistent.
If I have a point to make at all it is that 40% contribution over age 60 is very generous and at that stage possibly very affordable and it might have been a mistake to have maxed out your threshold by that time. But heck, so much can change that I guess I will go for "unused relief is missed relief and you might regret that".
 
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Duke of Marmalade said:
I have done a few sums. Assuming €28,750 is max available for relief and that salary remains constant going forward and funds grow at 5% p.a. I get:
If the guy is 30 then amazingly by the time he is 38 his prospective* pension fund assuming he stopped contributions would be greater than €2m**. He would be advised to stop contributing immediately and in fact he has earned less tax relief than he could have if he had waited so that he could get the increasing reliefs with age.
If the guy is 35 the age when he should stop contributing rises to 47.
If the guy is 40 then it is likely he can continue to claim max relief without hitting the threshold. I suppose this is the guy in your example as you talk of a 25 year mortgage.

If the guy expects his salary to rise it would be a further reason to delay pension contributions at least somewhat so as to enjoy the very generous 40% cap at 60 and over. If his fund by the time he reaches 60 is already "too big" he will miss out on these very generous reliefs.

*I have used 7% p.a. for the prospective calculation as if I used 5% p.a. I would be running a big risk of breaking the threshold.
** It is not just that the statutory threshold is €2m, beyond which there is double taxation, it is that at the margin the distributions on a fund this size would be taxed at 40%.
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Probably moot at this point in the debate but if the guy is in his 30s, his relief is capped at €23k (20% of 115k). It only goes to €28.75k once he hits 40 (25% bracket).

Great thread, this why I enjoy AAM.
 
thunderin_eejit said:
You can't assume that the age limits or taxation rules on funding pensions will still apply in 20/30 years, governments are too fond of meddling with pension rules.
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Very true.

For example, Sinn Fein are talking about reducing the earnings ceiling from €115k to €60k.

Another good reason to avail of the available tax relief while it remains in place at current levels.
 
Hypothetical - if I have a mortgage of €163,000 at 3% with 17 years left on the term and I want to work out how much paying off €1,000 today will save me (is worth to me) in the long term how do I calculate it?

Assume that 3% will be the rate for the remainder of the term and the term will remain the same.

The following formula doesn't take into account the reducing mortgage balance of 17 years. I'm not sure if it needs to?

€1,000 x (1.03 ^ 17)
€1,000 x 1.65284763
€1,652.85

In a sense, this is better than investing the same sum at 3% for 17 years because the benefit is received now (not in 17 years time).

Is my logic correct?
 
Páid said:
In a sense, this is better than investing the same sum at 3% for 17 years because the benefit is received now (not in 17 years time).
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Is there any difference?

If you assume an average expected return of 3% for investment and the mortgage payment then the full benefit won't accrue until the end of the period either way.
 
If you pay the €1,000 off now and keep the repayments the same, you will get a return of 3% a year for something short of 17 years.

So using your 3% formula is nearly right.

You would have to adjust it slightly for the return being higher or lower for the few months you will no longer have a mortgage.
 
Leaving aside tax, there is no difference between investing at a fixed rate of 3% for 17 years and paying it off your mortgage at a fixed rate of the same amount.

I don't understand what you mean when you say that you are getting the benefit now. There is no difference.

Such complicated long-term calculations can lead people to make mistakes.

Forget about 17 years.

Make the decision on a one year basis. Am I better off paying €1,000 off my mortgage now or investing it at the same rate? Answer: it makes no difference.

Am I better off overpaying a 3% mortgage or investing it in shares with an uncertain return, which will be subject to tax? Answer you are clearly better off paying down the mortgage.

Brendan
 
Brendan Burgess said:
Leaving aside tax, there is no difference between investing at a fixed rate of 3% for 17 years and paying it off your mortgage at a fixed rate of the same amount.
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If you invest now, you have to wait 17 years for the return.

If I pay €1,000 off my mortgage now, then interest will never accrue on that €1,000. Therefore I have effectively saved myself €652.85 in interest that I would have had to pay out over the next 17 years. I don't have that money in my bank account but I am that much better off today.

My point is that you are better off paying down your mortgage because the interest won't accrue.
 
Sorry, but that makes no sense.

I think that the 17 year outlook is confusing you.

Reduce it to one year and repeat your argument.

Brendan
 
I suppose it's a matter of perspective.

Do I owe the bank €163,000 only or €163,000 plus interest ?
 
I understand where you are coming from now. After year 1 you will look back and see that you have saved 3%. Year 2 you will look back and see that you have saved slightly more than 6%, etc.

€163,000 is today's redemption figure assuming that there are no penalties. If a person has that cash on hand it absolutely makes sense to pay it off because you would save a lot of money - €45,282.12 in interest (according to Karl's calculator) that would have accrued over the term of the loan.

Unfortunately, compounding also works for underpayments too. Those people taking mortgage holidays due to covid will see compounding on the amounts they did not pay accrue over the remainder of the term. €1,000 not paid now at 3% will cost €1,652.85 over 17 years.
 
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