Should you overpay your mortgage or invest?

How to use spare cash now to benefit you in the future

The past year has been an unusual one, to say the least, and it has affected everyone’s finances in different ways. While some people are finding it harder to make ends meet, others are finding it easier because they’re earning the same amount, but saving on old expenses, like commuting costs, holidays, and eating out.

If you’re fortunate enough to be saving money, or if you’ve received an unexpected windfall, you may be wondering how that extra cash can serve you best in the future.

What can you do with extra cash?

Your options for using spare cash (besides spending it) fall into three categories: paying down debts, saving, or investing.

If you have any outstanding, high-interest debts such as personal loans, it’s almost always the best use of your extra cash to pay these off. If your only debts are long-term, lower interest loans such as your mortgage, there are advantages and disadvantages to overpaying, which we’ll cover later.

Putting spare cash in a savings account is a second option, and it’s always sensible to have some cash savings to cover your living costs in case of an emergency. However, you’ve probably noticed that the interest rates offered on savings by most banks and building societies are currently very low or non-existent. So, while you can store you extra money in a savings account, it’s unlikely to grow.

Your spare cash has more growth potential if you choose to invest it rather than saving it, though the value of your investment can go down as well as up. We’ll explain the pros and cons of this approach too.

Why do people choose to make mortgage overpayments?

A mortgage overpayment is an additional amount you choose to pay to your lender, along with to your usual repayments, to lower your balance. You might decide to make overpayments:

  • To repay the loan quicker. Reducing your balance will mean you have fewer repayments to make before becoming mortgage-free. This is something you might especially like to consider if you’re close to the end of your mortgage.
  • To repay less in total. Interest is calculated based on the remaining balance of your mortgage, so by reducing that balance you can reduce the amount of interest you pay (and how much you pay overall).
  • Because interest rates on cash are low. If the interest rate you’re earning on your savings is less than the interest rate you’re paying on your mortgage, early repayment could leave you better off in the future.

What should you consider before making mortgage overpayments?

Your lender may charge a fee on mortgage overpayments, or may only allow overpayments up to a maximum percentage of the remaining balance – for example, 10%. You’ll need to check these conditions before making an overpayment as, if there are high fees and penalties, it may not be the best use of your money.

And if you’d prefer the potential to grow your money than reduce your debt, you should also consider investing.

Why do people choose to invest?

Interest rates for cash savings are currently lower than either the rate of inflation or the interest rates of many mortgages.

Instead, investing in a portfolio made up of stocks and shares, bonds, and other assets offers a potentially higher growth rate – though the value of your investments can go down as well as up. Some people are willing to accept that risk because of the higher growth potential over time and you could get back less than invested.

You can spend money you make from investing however you want. So, if you have a specific goal, such as paying for your children’s education or a family wedding, investing could help you take a step towards it.

What should you consider before investing?

Before investing, it’s important to understand the risk that you could lose some or all of your money. Some investments have a much higher level of risk than others, so you choose a risk level you’re comfortable with. For example, we offer ready-made funds at four different risk levels: lower, lower to medium, medium to high, and higher.

You should also plan to leave your money invested for at least 5 years +, as you should expect some short-term dips in value.

Something else to consider is making your investment as tax efficient as possible. If you invest through a general investment account, you may need to pay income tax and capital gains tax on the returns from your investments. If you use a stocks and shares ISAyou can make investments within your ISA allowance to protect them from tax.

For most people, the most tax-efficient way to invest is through a pension, because you’ll receive tax relief on top of the amount you pay in. So, for every £80 you pay in, the government will pay in £20, to total £100. Tax rules may change and are dependent on your individual circumstances. You can learn more about pension-related benefits such as tax relief here

Should you overpay your mortgage or invest?

Overpaying your mortgage and investing can both be sensible uses for extra cash, in the right circumstances.

If you’re comfortable with risk, there’s potentially more to gain by choosing to invest, though it’s hard to predict. How much money you get back will depend on the investment product, the risk level you choose, and the performance of the specific assets you hold. If you’re considering investing, find out more about our range of investment products.

If certainty is more important to you than possible growth, you might prefer to make mortgage overpayments. It’s fairly easy to calculate how much you might save by overpaying your mortgage.

However, everyone’s financial situation is different, so for advice that takes into account your unique circumstances, speak to a financial adviser. If you don't have an adviser, we offer tailored financial advice as well as a range of pension support. Find out more about the support that's right for you.

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