The rising prospect of 5% or even 6% mortgage interest rates in the UK means that so-called good debt could put horribly bad pressure on your standard of living.
Your mortgage debt is considered good because it is largely held to help you get rich. When high earners could borrow £500,000 for as little as £600 a month, we shouldn’t be surprised they chose to stretch.
But the same loan requiring repayments of over £2,000 a month may not seem so good, especially when accompanied by skyrocketing energy bills.
The average of new two-year fixed-rate mortgages crossed the 4% mark in August for the first time since the start of 2013. Amid turmoil in the pound and soaring government bond yields UK over the past few days, forecasts of mortgage rates rising to 6% are scaring borrowers. They’re scrambling for fixed-rate deals today, even though some lenders have temporarily suspended some deals.
Those with fixed rate contracts maturing over two years find that the overall average rate is 2 percentage points higher than when they entered into their contract, which equates to more than £200 a month more on average, according to comparison site Moneyfacts.
Meanwhile, the price of new mortgages has risen faster than UK interest rates. So last week’s hike in the Bank of England’s main interest rate to 2.25%, and likely further hikes, could cause even greater pain for the 40% of borrowers with interest rate deals. fixed that are due to expire this year or next.
For ultra-cautious savings hoarders with cash in the bank that is rapidly losing value due to inflation, now is a good time to make a mortgage down payment. It is, as they say, obvious.
But should those who are lucky enough to have portfolios of securities or who are thinking of starting investing cash out their holdings or abandon their plans – and pay off the mortgage instead?
Over the past 10 years, many investors believed they could generate returns that exceeded the cost of debt. But average mortgage rates are now several steps closer to average long-term equity returns: in the past, about 7% a year above inflation; in the next 5 to 10 years it is likely to be lower.
A grim prophet, Stephen Clapham, founder of investor education consultancy Behind the Balance Sheet, told audiences at the recent FT Weekend Festival that it would be a good result over the next five years if they could beat inflation and not lose money on their investments. .
Matt Conradi, head of client advisory at Netwealth Investments, told festival-goers it was less clear that investors could beat their mortgage costs as rates rise and markets struggle to digest the impact of the crisis. ‘inflation.
“Over the long term, we are more confident that the investments will generate significantly better returns than the cost of a mortgage. However, in the short term, with rising mortgage rates and market uncertainty, if you are a higher rate taxpayer, the balance of risk shifts in favor of the certainty that mortgage debt repayment provides.
If you still decide to go the investment route, there are steps you can take to improve your returns.
First, don’t miss your chance for tax-sheltered growth in Individual Savings Accounts (Isas) and pensions.
Isas provide non-taxable income in retirement and may give you the flexibility to retire or reduce your work before pensions. Your annual Isa allowance is £20,000 – and remember your spouse gets one too.
With pensions, the tax relief on entry in addition to continued tax-free growth can have a greater impact, despite potentially paying taxes on withdrawals.
If you use your full £40,000 annual retirement allowance and get tax relief at a higher rate, it will only cost you £24,000. That’s an instant 66% increase in your investment. Where else can you get this without taking excessive risks? Yes, it is locked up until 10 years before your legal retirement age, but after that you can withdraw 25% tax.
Netwealth compared a £10,000 mortgage down payment with the potential outcome of investing in retirement. Over 20 years, on a fixed rate of 5%, the mortgage would be £26,533. If the pension increases by an average of 5.2%, Netwealth’s estimated returns on a portfolio invested 90% in stocks and 10% in bonds, it would have a cumulative net benefit on the mortgage of £2,487 for a taxpayer in the base rate and £5,237 for a higher rate taxpayer.
However, using the same growth assumptions against a 6% mortgage, the benefits of the pension are reduced, with the mortgage down payment winning for basic ratepayers and higher ratepayers, but by just £300 for the higher rate taxpayer.
If you have already used the annual pension and annual Isa allowances, you invest using a taxable general investment account. A tax-efficient way for those cashing in investments into a general investment account that has increased in value would be to use your annual £12,300 capital gains allowance to make the overpayments.
It might be worth doing. Using the same growth assumptions of 5.2% over 20 years, Netwealth calculates that a base rate taxpayer choosing to invest could lose £4,333 compared to the certainty of paying off a 5% mortgage, and that a higher rate taxpayer could lose £8,633. On a 6% mortgage, the potential losses are £9,871 and £14,171.
You would need to take high risks – invest 100% in stocks and aim for impactful annual returns of 10% or more to make the investment the potential winner. And you could still lose.
But, if you’re determined to keep investing, here’s some comfort.
Any extra money you throw at the mortgage is hard to access immediately – for example, if you’ve lost your job or had poor health. As the recession approaches, you may want this financial flexibility.
Also keep in mind that the average homeowner is overexposed to residential real estate. So beware of increasing it. Property experts expect the cost-of-living crisis to dampen what has been rapid growth in property prices (despite the government boosting activity thanks to a new tax incentive). stamp).
Calculate the value of the equity held in your home as a percentage of your overall equity. Some UK financial advisers recommend that 30% of net worth in residential property is ideal. You might already have a much higher exposure.
Being a borrower with a fixed rate mortgage is a classic hedge against inflation. The value of your home might go up, but your fixed rate loan won’t change and might seem less burdensome after a few years of higher inflation reducing the purchasing power of our books. Sure, your house might lose value but, in the long run, that hasn’t been the British experience.
Note that these are mostly rational arguments. Emotion will also play a part in your decision.
Your personal appetite for risk is different from that of your friend or relative, or even your younger self. As you build wealth, a little more can mean less of a difference in your life. You can simply choose to reduce your risk rather than increase your returns.
How would you feel, think or live differently if you didn’t have a mortgage? If your mortgage feels like a mental burden, preventing you from changing careers, or causing arguments at home, make it your priority.
Not everyone wants to collect art, fly first class or drive a Porsche. If being mortgage-free is your luxury of choice, a status symbol that just makes you feel good, that’s perfectly valid.
In any case, the repayment of the debt should not be eternal. It may be possible to get a larger mortgage later. Don’t expect interest rates to return to historic lows.
Moira O’Neill is a freelance writer specializing in money and investing. Twitter @MoiraONeill and Instagram @MoiraOnMoney