Should you overpay your mortgage or invest?

Millions of households due to remortgage this year will see a hike in their monthly mortgage repayments, despite the fact the Bank of England (BoE) has been gradually cutting interest rates for over a year, which are now at 4.5%.

Mortgage rates have been falling as inflation has slowed but remain higher than in recent years.

After enjoying years of paying interest of less than 2% on home loans, many borrowers coming to the end of a fixed-rate deal face remortgaging onto deals at a higher rate, which means higher monthly repayments.

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Those with spare cash may be wondering if it’s best to overpay their mortgage to reduce the debt quicker and to be in a better position when it comes to remortgaging.

On the other hand they might wonder if investing the money would get a decent return.

We look at how the two options compare, and which one might be right for you.

The benefits of overpaying your mortgage

Overpaying your mortgage means you can reduce the amount of interest you pay and clear your debt faster.

For example, someone who borrowed £250,000 over the course of a 25-year mortgage would pay £1,186 a month, assuming an interest rate of 3%.

If you overpaid by £200 a month, you’d save £22,812 in interest and reduce your mortgage term by five years.

For someone with the same £250,000 mortgage, but a 5% interest rate, overpaying by £200 a month means you'd save £44,427 in interest and reduce your mortgage term by six years. This assumes your mortgage rate remains the same.

So, overpaying when your mortgage rate is higher can have a bigger impact; you can dramatically reduce the amount of interest and become mortgage-free quicker.

Have a look at our mortgage overpayment calculator to see how much you could save based on your own situation.

Overpaying your mortgage may also help when you come to remortgage. Reducing the loan-to-value (LTV) on the mortgage may open up a broader range of better rates. On top of that, a smaller mortgage should mean that affordability criteria is easier to meet - which again may open up a broader choice of rates.

Rob Morgan, chief investment analyst at the wealth manager Charles Stanley, comments: “One thing is for sure, you’ll save thousands of pounds in interest by paying your debt down sooner. The longer you have the mortgage and the higher the interest rate, the more you pay in interest. This is especially true in the early years when the loan balance is larger, and you are proportionally paying a lot more on the interest than the capital.” 

What to consider before you overpay your mortgage

Overpaying your mortgage is generally considered to be savvy financial planning. However, there are a few things to consider first.

Evangelos Assimakos, investment director at Rathbone Investment Management, points out that households should have a decent cash buffer of at least three to six months’ worth of outgoings before they consider investing or overpaying a mortgage.

This buffer should be held in an easy-access savings account, which can be used for any unexpected financial expenses, such as the boiler breaking down, or your energy bill suddenly rising.

“If you have excess cash over and above three to six months expenditure, tackle the highest interest debt first (credit cards, loans, and overdrafts). If you have no such debt and only have a mortgage, only then should you consider paying it down,” says Assimakos.

Credit cards and loans are often more expensive than mortgages, so try and pay those off first.

If overpaying your mortgage seems like the best use of your surplus savings, there are two more things to check. First, find out if there are any overpayment penalties. Most lenders allow borrowers to overpay up to 10% of their remaining debt each year. If you exceed this, you could be hit with hefty penalties.

Second, make sure you’re actually reducing your mortgage term, rather than reducing your future repayments. This will ensure you pay off your mortgage faster and pay less interest.

Should you invest rather than overpay your mortgage?

According to Morgan, overpaying your mortgage comes with an “opportunity cost”. He explains: “In other words, had you invested the money, could you have achieved a return in excess of the interest on the debt?

"Building wealth over decades by allocating capital to well-managed and growing companies has, historically at least, been a reliable way to grow wealth. However, to fully harness the power of the stock market and enjoy the benefit of compounded returns, you need to leave your money invested for a long time.”

So if you invested instead, and your portfolio returned 5%, this will have been a smarter move than overpaying a mortgage with a lower rate of say 3%.

However, mortgage rates are currently around the 5% mark, and so there is arguably less of an opportunity cost.

“It is one thing bettering a 2% or 3% rate with investment returns, but achieving upwards of 6% consistently is much more difficult. The higher interest rates are, the more it makes sense to repay debt as quickly as possible,” says Morgan.

As well as comparing the numbers, it’s important to think about how much risk you’re willing to take.

Assimakos notes: “The key consideration is that investing is a longer-term endeavour, and you need to be comfortable leaving your money invested for at least three to five years, as well as accepting that markets can be very unpredictable, and you can lose money.”

On the flipside, compounding returns and investing as much extra money as possible over a long time-frame can be a hugely powerful force – provided your investment strategy is sound.

Is investing a good idea right now?

You may be wondering whether it’s safe to put your money in the markets at the time you want to invest.

There’s never really a perfect moment to invest, so when it comes to choosing when to do so, it’s best to remember the adage – it's not about timing the market, but about time in the market.

There’s no doubt that investing means accepting the risk that you might lose money. But if you know you can invest your money for at least five years, the fluctuations of the market shouldn’t concern you much as you’re in it for the long haul and so your money will have time to recover any losses.

“Time in the markets, rather than timing the markets, is always the secret to riding out any declines," says Alice Haine, personal finance analyst at Bestinvest, the investment platform and coaching service.

If you are certain that investing is the right route, you can get started when you’re ready.

Investing vs overpaying: how can I decide which is better for me?

Ultimately, the decision to overpay a mortgage or put money into investments depends on your circumstances, stage of life and your time horizon.

For example, someone about to retire with a mortgage still in place should arguably focus on paying off their home loan first to free up income for other living expenses. Meanwhile, someone in their 20s might want to invest their spare cash to take advantage of time in the markets.

Haine highlights another scenario: “If household cash-flow is tight, those with spare cash and a mortgage expiring soon can direct their money towards overpayments rather than topping up investments.

"This will become even more important as property prices decline, as overpaying protects the loan-to-value ratio, which can determine access to more favourable mortgage rates.”

Experts agree that depending on the amount of spare cash available, an ideal solution could be to overpay your mortgage and invest.

The former means you can get ahead of higher repayments if you’re going to be remortgaging soon, and make you more financially resilient as you pay down debt. Meanwhile, investing can help beat inflation and grow your wealth.

It’s worth remembering that once you overpay on your mortgage you’re not able to get that money back. If you invest it, while ideally you’ll leave it invested, it’s there in the event you need to get your hands on funds.

Our "what is an offset mortgage" looks at other options for homeowners.