Overpaying is an investment with a guaranteed return; investing may earn more, but with no guarantee. Here is how to compare them.
Key findings
- Overpaying earns your mortgage rate, risk-free.
- On 150,000 at 3% over 25 years, overpaying 10,000 in the first month to shorten the term saves 10,377 in interest.
- Investing only makes sense if you expect to beat that rate comfortably, with money you can leave alone for years.
The age-old question
You have some savings and a mortgage. Do you use the money to pay down debt early or invest it? There is no single answer, but there is a clear way to think about it: overpaying is an investment with a guaranteed return equal to your mortgage rate. Investing may earn more, but with no guarantee.
How much you save by overpaying
Take a 150,000 mortgage over 25 years at 3%. The payment is 711.32 a month and, in total, you would pay 63,395 in interest. If you overpay 10,000 in the first month:
- Shortening the term, you finish 28 months early and pay 53,018 in interest: a saving of 10,377.
- Lowering the payment, you pay 663.79 a month instead of 711.32 and save 4,211 in interest.
Shortening the term saves more interest; lowering the payment gives you more room each month. Before deciding, check whether your lender charges an early repayment fee.
How much you could earn by investing
The same 10,000, invested for 25 years, would grow to 20,938 at 3% a year and to 33,864 at 5%. The gap between the two, 12,926, is what you could gain if your investment beats the mortgage rate. But it is not guaranteed: it could earn less, go through sharp falls along the way and bear taxes and fees that overpaying does not.
How to decide
- Emergency fund first. Money you put into your mortgage cannot be taken back out if you need it. Before overpaying or investing, keep a few months of expenses aside.
- Compare with your mortgage rate. The higher it is, the more attractive overpaying becomes: it is a safe return. With low rates, long-term investing has more room to make up for the risk.
- Think about time and peace of mind. Only invest money you can leave alone for many years. If seeing your investment fall 30% would keep you up at night, overpaying may be the better choice even if it earns less.
- If your mortgage is variable, overpaying also reduces the risk of your payment going up.
Many people split the difference: overpay with part and invest the rest. Run the numbers for your mortgage with the mortgage calculator and compare with what an investment could earn in the compound interest calculator.