May 15, 2023

Pay off debt or Invest?

We are taught that you should repay debts before investing, is this still the right thing to do?

It is a question I get asked a lot and has popped up a few times recently. Which is only to be expected because interest rates have been increasing. Like with most things in life and financial planning is no different, it depends on your circumstances.

The answer can be fairly obvious…. If an individual has an outstanding balance on a credit card, typically the interest payable would far exceed any realistic investment returns so in this situation the focus should be on repaying their credit card.

The interesting one for me is a mortgage, this is a debt most of us have for a significant period of our lives. Therefore, should an individual consider repaying the mortgage in full before saving for their retirement.

If an individual saved hard and paid off their mortgage by the time they reached fifty, and then started saving the equivalent of their mortgage payment of £1,500 per month into a pension, they would have built a pot worth £413,025 by the time they reached sixty-eight.

Now if another individual saved £500 per month into a pension from the age of twenty-five, they would have saved £465,314 by the time they reached sixty-eight.

Please note this assumes a 5% investment return, contributions increasing by 2.5% per annum and are in today’s terms.

Now there are several things at play here and other factors need to be considered which include and are not limited to:

      I.         The mortgage interest over the lifetime of the mortgage. You can fix your mortgage for a period of time but an individual is unlikely to have fixed it for the whole term, therefore this is impossible to know from the outset. Interest rates have change dramatically from the early 90’s when mortgage rates were in double figures to post credit crunch where they hit rock bottom.

     II.         An individuals tax position. If they are a basic rate tax payer 20% tax relief is added to their contributions, higher rate tax payers get 40% tax relief.

Whilst this is a simplistic view, the point I am trying to make is the earlier an individual starts investing and the longer the investment time frame the better the outcome will be (compound investment returns are the eighth wonder of the world). The general rule.....I would not subscribe to the feeling that a mortgage would need to be paid off in full before an individual starts saving for their retirement.


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