Key Post Overpay mortgage or contribute to pension or do something else?

Brendan Burgess

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This comes up in a lot of different threads, so I will set out some principles here to kick off the discussion. I will edit it in the light of feedback.

There are many options with your savings in excess of your emergency cash fund
  • Pay down your mortgage
  • Build up a fund to enable you to trade up
  • Maximise your pension contributions
  • Build up a fund for your kids' education or some other long-term need
  • Build up the deposit to buy an investment property
  • Invest directly in the stock market - i.e. outside a pension fund
 
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You should consider paying down your mortgage
  • when it is high as a multiple of your income. This is a matter of judgement. A mortgage might be uncomfortably high in relation to your income if your job is insecure or if you are thinking of taking a break to mind the kids
  • when you have a high loan to value. If your loan to value is in excess of 80%, it is too high and your first priority should always be to get it below 80%. 80% is a key threshold as mortgages are usually cheaper below 80% LTV and it's easier to switch to other lenders.
  • If you might be trading up at some stage in the future and will need to sell your existing home to do so. If you trade up, you will need a deposit of at least 20% of the price of the house you are buying. So make sure you have this amount in equity in your current home so that when you sell it, you will have the deposit you require.
  • If your LTV is just above one of the rates thresholds. For example, the lowest mortgage rate is available for mortgages of less than 60% LTV with Avant. If your mortgage is at 62% LTV, then it's worth overpaying it to bring it down to below 60%.
Some technical reasons for not overpaying your mortgage even if you meet some of the above criteria

You might meet one or more of the above criteria, but it might still be better to wait before overpaying it
  • You are in the 5th year of a cash-back mortgage and will get the 1% bonus for staying 5 years
  • You are planning to switch to another cash-back lender and so the more you borrow the bigger the cash back.
  • You face a big penalty for early repayment of a fixed rate. However, usually the interest saved well outweighs the penalty.
 
Some cases where overpaying your mortgage might not be the right thing to do

  • Where you have a very cheap tracker mortgage
  • Where you are trading up and do not need to sell your house to trade up
  • Where your mortgage is very comfortable but your pension is underfunded
  • Where you will need access to the cash in the short to medium term e.g. to buy a new car or to pay for your kids' education
 
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When you have a very cheap tracker mortgage...
If you have a cheap tracker, it's nearly always right not to overpay it.
  • Maxing your pension contributions at a cost of 0.5% must be worthwhile.
  • If you have any medium or even long-term spending commitments e.g. a child's education it's costing you only 0.5% to keep this money in a current account.
  • If you are thinking of trading up, then most lenders allow you to move your tracker to the new house subject to an increase in rates of 1%. So if it's even a vague possibility, it would be better to not overpay your mortgage.
Where should you invest your money if you have a cheap tracker?
  • If you will need the money in the short term, for example, you might buy a new car or trade up within 2 years, then it's probably best to keep it in a current account.
  • If you have maxed your pension, and you are investing for the medium term, you should invest in the stock market. Either buy shares directly or buy an Exchange Traded Fund. Stock market returns are volatile and you might lose money, but the potential returns justify the risk.
 
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If you are planning to trade up, is it better to overpay your mortgage or build up the deposit instead?

If you will need to sell your home to trade up, then you should overpay your mortgage now.

Most people need to sell their existing home to trade up. For these people, it's right to overpay the mortgage over almost everything else.
  • As a minimum you will need 20% of the price of the new house.
  • But the more you have the easier you will find it to get a mortgage. For example, if you are borrowing only 70% of the price of the new home, you might get an exception on the Loan to Income limits.
  • And the lower the LTV, the lower the mortgage rate you will pay
You should not be putting your money away into a pension fund which you cannot access. The only exception to this is where your employer matches your contributions.

If you can trade up without selling your existing home, you probably should not overpay your mortgage



If you pay off your mortgage with the €100k, you won't be able to buy your new house without selling your existing house.

If you hold onto the cash, then you can buy a new house with a €400k mortgage. Not having to sell your existing house has so many advantages:
  • The seller of the new house will usually only accept offers from people who are not in a chain
  • You can buy the new house and move in without trying to synchronize the selling and buying.
  • If you need to refurbish the new house, you can stay in the old house while you are doing it
When you have moved into the new house, then you can make the separate decision as to whether keeping the old house as an investment is right for you.
 
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The following factors would suggest maxing your pension ahead of paying down your mortgage - assuming you get tax relief at the top rate on the pension contribution:

  • Where you have a cheap tracker. Borrowing at 0.5% to invest in your pension is a good idea.
  • Where you don't intend to trade up for at least 5 years.
  • Where you have a comfortable mortgage
    • LTV <80%
    • Loan to Income < 2.5
  • The older you are the higher priority your pension is because you have less time to catch up.
 
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Why is overpaying your mortgage better than investing in a stock market fund?

If your mortgage rate is 3%, then overpaying it is exactly the same as an investment which gives you a guaranteed return of 3% after tax.

Could an investment in the stock market do better than that over the long-term? To get a return of 3% after tax, the fund would have to get a return of at least 6% before expenses and tax. That is a very high standard and could only be got by quite a high risk.

So yes, an investment could beat the 3% after tax return you get by overpaying your mortgage, but the return could also be -3% a year or more.

Should you overpay your mortgage or build up a children's education fund?

This is quite a difficult balance to get right and we can give just some general guidelines here.

  • If you can pay the costs of education out of your income, then you don't need to have a separate fund. Paying down the mortgage is a better use of your money.
  • If you are going to face big costs in the short term e.g. in two years, then it is probably better not to overpay your mortgage.
  • If you are not going to face any costs for 10 years, then overpaying your mortgage is the right strategy.
 
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As the poster of the above thread, who was later steered in the right direction, I thought it might be helpful to offer a word of caution to anyone who's very optimistic about after-tax investing in equities in Ireland (i.e. not in a pension) while they have a non-tracker mortgage.

Like many people in lockdown this year, I had to find something new to do to pass the time. I was applying for a mortgage and ended up developing an interest in personal finance / investing. The first place I normally go for info is the internet. I'd browse personal finance subreddits, forums posts etc ... and I ended up reading a few books (e.g. Bernstein's Four Pillars of Investing, JL Collins Simple Path to Wealth). I'd say a lot of the info and many of the fundamental principles from these books are worth learning about.

My word of caution is: most of the investing information that you'll find recommended online is very US-centric.

Strategies like "FIRE" can work in the US because it's got low taxes, low expenses for investing and various other things that make it viable. You'll be able to see in the above thread why after tax investing in equities while you have a mortgage in Ireland may not be a good idea, namely: high taxes, high investing expenses, high mortgage interest rates and no mortgage interest relief. High rents in Ireland also probably mean that getting a house / mortgage will be better for your finances in the long term, so the range of investment options available to you in practice may be narrow.

This might be a bit of a bitter pill to swallow. On the other hand, Ireland is a society where people don't face financial ruin if they get into a bad accident. I know where I'd rather live. Paying off your mortgage early isn't sexy and it's unlikely to make you rich, but in most cases it seems to be a very sensible way to invest your money.
 
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Doesn’t a lot of this depend on the person’s intentions in relation to their home?

A lot of people have no intention of moving, in which case there’s a downside to lashing all of one’s money against the mortgage.
 
Hi Gordon

I think I have covered all the situations where one would need cash?

Brendan Burgess said:
There are many options with your savings in excess of your emergency cash fund
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Brendan Burgess said:
Build up a fund to enable you to trade up
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Brendan Burgess said:
  • If you are going to face big costs in the short term e.g. in two years, then it is probably better not to overpay your mortgage.
  • If you are not going to face any costs for 10 years, then overpaying your mortgage is the right strategy.
Click to expand...

Brendan Burgess said:
Where you will need access to the cash in the short to medium term e.g. to buy a new car or to pay for your kids' education
Click to expand...

Brendan Burgess said:
Where you are trading up and do not need to sell your house to trade up
Click to expand...
 
Gordon Gekko said:
You can never access the value.
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For most people with spare cash it's an option of overpay mortgage or make AVCs. In both cases the value is pretty inaccessible short to medium term.

For me the more important factor is return. Over decades you will probably get a better return on AVCs.
 
I’m not sure that’s fair.

Making pension contributions trumps overpaying one’s mortgage in my view.

The question is whether overpaying one’s mortgage trumps investing in one’s own name.
 
Hi Gordon

The point of this thread is to tease out those questions.

I have tried to address these systematically. And cater for the different sets of circumstances.

Are there cases which I have not already catered for, where it would be better for someone to invest rather than to overpay a non-tracker mortgage?

Brendan
 
Well I did the "something else" and I posted about it this morning but my post was deleted as not being relevant.
 
In this post I did some maths on maxing out your pension contributions (and benefiting from the tax relief) versus overpaying your mortgage.

From my point of view there is no contest: pension contributions win hands down (if you believe that the long-term future of the stock market will be more-or-less like the past).

But there are occasions (see Brendan's second post, above) where overpaying the mortgage can make more sense than maxing out your pension contributions. Note that most of those are relatively short-term situations: most of the time, a pension contribution is the better choice.
 
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