Repaying your Mortgage

Your tax position is likely to make this a good use of savings.


The economics

There is no tax relief on mortgage payments. Put this another way: you pay mortgage interest out of taxed earnings.

If you invest in a deposit account you will pay tax on the interest (unless you qualify for one of the special reliefs available). So, to compare one with the other you will have to 'gross up' the mortgage interest rate at your marginal tax rate. Best to do an example:

  example.....  
 

You are a 40% taxpayer with a mortgage at 3%. If you have £10,000 saved and you use it to repay part of your mortgage you will save £300 per year. If you place it on deposit at 3%, and your marginal rate of tax is 40%, you will earn £300 gross less tax of £120, equals £180. Better to save £300 than earn £180.

Put this another way, if your mortgage rate is 3% you need to earn at least 5% over the remaining life and terms of your mortgage to make non-repayment a sensible option. 5% is described as '3% grossed up at 40%'.

 
     

This is a pretty compelling argument for repayment. On the other hand:

  • Your mortgage may have early repayment penalties.
  • You may have a fixed rate mortgage that now looks pretty cheap (but just do the maths).
  • Cash is king. If you need money it's not as easy to remortgage as it is to take money out of a deposit account.
  • As a mortgaged homeowner you are a member of a politically powerful group. The government cannot allow anything too nasty to happen to you (as a group).

All these argue in favour of keeping the mortgage and banking the cash.

Our advice

You will have your own tax and mortgage interest position to consider. But for many people mortgage repayment is likely to be a good use of savings. We recommend that early mortgage repayment is a good working assumption until you can prove to yourself that you have a better use for the money.

One way of testing this is to work out your grossed up mortgage interest rate (5% in the above example) and carry that forward into the Simple Investing module. This will lead you through a 'What Assets?' decision process where you can include a 5% (example) deposit account as an option.

What next?

That's the last step of the 5/95 plan. You have arrived at a set of financial decisions that seem sensible. What you have not done is to peer into the future to see the consequences of those decisions. Nor have you learned how to invest any surplus savings. To do either of those things you must move on, in your own time, to Saving, Investing and Planning.

 

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