Should you invest or pay off your mortgage?

Ugh. What a question.

Spoiler alert 🚨 … it depends.

Here’s why.

We’ve become accustomed to an era of ultra low borrowing costs.

In the wake of the 2007/08 financial crisis we’ve balked at the pitifully low returns on our cash savings, yet at the same time partied in an environment of cheap and cheerful debt for over a decade.

The Bank of England base rate (*read – the mother of all interest rates, upon which other interest rates are set*) has hovered under 1% for several years.

Borrowing has been incredibly accessible, and for most, incredibly affordable.

Here’s how it’s played out over the last 20+ years:

Source – Bank of England, official base rate

The rapid spiralling of the base rate since mid 2022 has naturally prompted new questions around where our financial priorities should lie 🤔…

The diligent investors out there who regularly tap into the greatest companies in the world (I’m talking investing in the stock market) are now asking themselves:

With spiralling interest costs, should I stop investing and pay off the mortgage sooner?

Admittedly, high interest rates can test the short term returns we see on our investments.

It’s a challenging time for both equity and bond markets.

Yes you can earn more in cash than you’ve done for many a year, but remember that cash is never king.

Once you’ve built up an adequate emergency fund and accounted for any expenses coming up in the next couple of years, you should be looking to invest beyond cash.

The Terminator of Wealth that is inflation has no time for cash when it comes to long-term planning and meeting your future goals (and neither should you).

The answer to the question posed at the start of this article essentially comes down to two opposing factors: human emotion versus hard maths.

Herein lies the debate…

The irrational human versus rational mathematics

Let’s take the perspective of ‘maths’ first of all…

When interest rates previously sat at a happy 0.5% against a backdrop of long-term equity market returns of 9% per annum, you wouldn’t need a degree in maths to tell you that financially you would’ve been better off investing in the markets and using the proceeds to pay off your mortgage.

What rational explanation could there be to pay off debt when the costs of said debt are so low?!

Financially. On paper. You would’ve been better off investing in the markets.

But…

And it’s a rather hefty one…

With interest rates (and thus mortgage rates) on the rapid rise, has momentum switched in favour of now paying off a chunk of your mortgage in a desperate bid to avoid crippling interest costs in the long term?

Again, it comes down to maths.

In simple terms, if you rely on the enduring power of financial markets over long time periods, then you’ll be rewarded handsomely.

And in the meantime, you simply suck up your borrowing costs.

Invest and forget.

As long as the return you get on your investments exceeds the level of interest you pay on your debt, you’re winning. And history has told us that a well diversified portfolio, tilted heavily to coat-tail investing (what I call equity investing) is the ultimate long term wealth creation strategy.

Easy peasy.

Debate over.


Not quite.

That’s where this edition’s dark horse comes in folks.

Enter… the irrational human being.

We don’t live our lives according to mathematics.

As human beings… we are indisputably, incomprehensibly, unfathomably irrational.

And often no more so than when it comes to our personal finances.

In the context of this debate, we like to be debt free.

It’s ingrained in our psyche… debt is a bad thing.

Debt should be paid off.

And so it’s perfectly natural to feel the need to prioritise paying off your mortgage even if on paper it might not be the most sensible course of action.

Human beings- 1, maths- 0.

Similarly, history has told us that over long time periods, the average return in equity markets is around 9% per annum.

But it’s certainly not a linear return.

When it comes to investing your hard earned pennies in the wealth creation engine that is the stock market, you need to accept that in some years things won’t look quite so rosy.

In fact, you can broadly expect that 25% of the time things won’t look pretty at all.

If you can stomach the highs and lows of the stock market, knowing you’re playing the long term game then you’re a far more rational human being than the population.

Sadly however, most human beings just don’t operate like that.

It’s what keeps me in a job.

Paying off a known debt is often far more palatable than paying into something that constantly changes in value.

As a financial planner, I can tell you that more often than not investing is the better course of action.

But as a fellow human being (yes, financial planners are humans too!) I get where you’re coming from when you opt to prioritise debt repayment.

Especially at the moment when interest rates are the highest they’ve been for years.

So.

What do I do now?

I hear you ask.

Step 1. Listen to my podcast on this one to understand more about how the maths works in real life and understand the numbers (it’s not complicated, I promise).

Apple listener? – Listen up here.

Spotify fan? – Listen up here.

Step 2. Crunch your own numbers using this calculator that I love (yes, I am that sad).

There really is no right or wrong answer here folks.

Whichever route you take, have conviction and confidence in your path, as often making sudden changes to the plan can be more disastrous than opting for the wrong plan to start with.

For those that are still locked into a lower mortgage rate the debate will perhaps be more clear cut.

As for others, the imminent increase to your mortgage rate may lead to a refinement of your priorities.

Often, the best approach can be finding a sweet spot between the two.

Until next time.

Benjamin

Benjamin Mitchell

Benjamin Mitchell

I’m a chartered financial planner that can help you plan for tomorrow and also live for today.

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