The year is 2016. Interest rates have been low since the financial crisis of 2008. Katie and I are coming to the end of our first 5 year fixed mortgage rate and are wondering if we should fix in for another 5 years, should we stay with the variable rate, or should we pay off our mortgage quicker as interest rates will only go up!

Since 2012, when we got our first mortgage, we were thinking interest rates will only go up. Our mortgage was at 4% and we were scared it could go up a lot. We had stress tested our numbers and we could survive if rates went up to 7% or slightly more.

The question was, should we pay off the mortgage quickly or should we invest our gap/spare money instead. We had already learnt about index investing, we were on our way to financial independence and we understood the power of investing over time.

We could take a guaranteed saving of 4% by paying off the mortgage or we could take a risk; invest our money and see what happens. There are no guarantees in investing, but there is a LOT of data to prove it will probably go well over time.

We chose to invest; I knew the numbers. If we invested, we expected to see a 10% increase a year (or more) and we chose to fix our mortgage at 4% for another 5 years. I expected we would do much better investing. We took all our spare cash, all our gap and put it into index funds.

The question is should you invest? Or should you pay off your mortgage ASAP?

Katie and I talk a lot about maths and emotion on Rebel Finance School. These are the two elements to any financial decision. The maths of the finances and the emotion of how you feel. It is a lot easier to be less emotional, more Vulcan when you are dealing with investments, but when dealing with the home you live in, emotions can come up.

Recently there was a post in the Rebel Finance School group asking this exact question. Should I pay off my mortgage or should I invest instead? There was lots of debate back and forth, but one comment stood out for me. The commenter said “There is NOTHING like the feeling of paying off your mortgage and the security it gives you. You should always pay it off first.”

I was surprised at the strength of the conviction and belief. I probably shouldn’t have been. My first thought was the commenter obviously valued security over everything else and they had convinced themselves that paying off a mortgage is the ultimate security.

Lots of people believe this. I actually believe that in most cases, this need for security is based in fear. Fear of losing their home; what if they take my home, they can’t take my home if I own it 100%. Those fears then drive an action that makes that person worse off financially.

We have met so many people that have paid down their mortgage religiously, sometimes because they didn’t know what else to do, and then, they get to later in life, they have their house but nothing else to look after themselves. They don’t have investments and they don’t have much put aside to live off. They are property rich but all that money is locked up and not providing for them.

Let’s imagine another scenario. Instead of paying off the mortgage, you invest your extra cash. That money you invest grows. In our instance, the actual returns of the Vanguard FTSE Developed World Ex. UK, that we have invested in, has grown by 13.6% annually since inception.

Your money grows. Your mortgage goes down slowly as you are normally paying the minimum payment. After ten years of investing, your mortgage has shrunk a bit but that excess money invested has grown massively. In your investment accounts you have way more money than your mortgage. Compounding has taken affect.

You could pay your mortgage off by selling some of your investments if you liked. Having enough to pay off your mortgage in one fell swoop; would that give you the same level of security or more?

It is at this point that we get into a big debate. The people that have been paying off their mortgage quickly don’t want to be wrong, so they come in with lots of stories and no mathematical back up. They say things like:

• Elimination of Debt: Owning a home free and clear means no more mortgage payments, providing a sense of financial freedom.
• Interest Savings: Paying off a mortgage early can save a significant amount in interest payments over the life of the loan.
• Guaranteed Return: Unlike the stock market, paying off your mortgage offers a guaranteed return on investment equal to the interest rate of the loan.
• Reduced Stress: For many, debt is a source of anxiety. Paying off a mortgage can lead to greater peace of mind.
• Increased Cash Flow: Without a monthly mortgage payment, homeowners have more money available for other expenses or investments.
• Simplicity: A paid-off home simplifies one’s financial situation, making it easier to manage.
• Retirement Preparation: Entering retirement without a mortgage can reduce the amount of income needed to maintain one’s lifestyle.
• Housing Market Protection: Owning a home outright can provide a buffer against housing market fluctuations.
• Wealth Building: A mortgage-free home is a valuable asset that can be part of one’s estate.
• Personal Satisfaction: There is a deep sense of accomplishment that comes with fully owning one’s home.

There is a HUGE amount of truth in these statements above. There are also a lot of things that are just not mathematically correct at all. In fact, I would say that some of the rhetoric that says paying off the mortgage is best all the time, is damaging and doesn’t truly understand the economic impact.

What I want to reply is:

• Opportunity Cost: By paying extra towards the mortgage, you miss out on the opportunity to invest that money in the stock market, which historically has higher returns. This is a HUGE cost and for us helped us get to financial freedom far faster than if we would have paid down our mortgage.
• Inflation Diminishes Debt: Over time, inflation reduces the real value of your mortgage payments, making it cheaper to pay later rather than sooner. By the end of our two 5 year mortgage terms, the minimum payment was around £350 a month. It felt like nothing by that stage.
• Liquidity: Investing provides more liquidity than home equity. You can access your investment funds if needed, whereas home equity is tied up in your property and it provides nothing for you later in life. It does reduce your expenses but it gives you nothing to live off!
• Compound Interest: The power of compound interest in investments means your money can grow exponentially over time, normally outpacing the interest saved on a mortgage. Imagine the power of your money growing at 13% annually versus the saving on a mortgage of 4%.
• Flexibility: If you invest rather than pay down your mortgage, you have the flexibility to use those investments to either pay off the mortgage at the end of the term or use for other things.
• Mortgage Rates: With historically low mortgage rates, (although they spiked in 2023) the cost of borrowing is cheap, and the money saved on interest by paying off early may be minimal compared to potential investment gains. This is where we start to get the crystal ball out and work out if mortgage rates will remain low or rise again.
• Retirement Savings: By investing early and often, you can build a significant retirement nest egg that can provide a comfortable lifestyle. We have seen so many people prioritise their mortgage and then have NO retirement investments.
• It’s not binary: Then comes Katie’s favourite expression. It’s not binary means you don’t have to do one thing or the other. You could take half your gap and pay down your mortgage and then use the other half to pay into your pension, ISA or other tax advantaged accounts. You could split your gap to do different things for you.
• Stories: We tell ourselves lots of stories to help us feel better. It is not the house that gives this feeling of security, it is the story that you make up around it. You give yourself a sense of security by saying “they can’t take my house away from me”. Could you get the same sense of security from having double your mortgage total invested?

Maths or emotion. The above reasons are all stories, beliefs about property and investing that aren’t backed up by maths. There is some truth in all of them!

Katie and I believe in doing the maths first and then examining our emotions in the cold hard light of the numbers. Let’s see if it actually makes sense financially to pay off your mortgage or not.

Let’s look at a fictious example but using the Vanguard FTSE Developed World ex. UK fund we invest in and the real investment growth. This fund has grown 13.6% a year since inception.

We will use mortgage rate of 5% for the comparison. Some of you will have mortgage rates greater than this currently, and some of you have locked in at lower rates for some time.

From 1995 until 2022, the average mortgage interest rate in the UK averaged 5.62%.

Let’s assume you have a mortgage of £200,000 at a 5% interest rate with 20 years remaining. Your monthly payment would be approximately £1,319.91, totalling a repayment of £316,777.40 over the 20 year term. You would pay a total of £116k interest over the term of the mortgage!

Let’s imagine you have an extra £500 per month that you could either use to pay down the mortgage or invest in the Vanguard fund.

If you choose to pay down the mortgage, you would pay it off in approximately 13 years and 4 months, saving around £60,000 in interest! That sounds amazing, doesn’t it?

However, if you invest that £500 monthly in the Vanguard fund with an average annual return of 13.6%, after 13 years and 4 months, your investment would grow to approximately £195,582. Even better!

It won’t always grow by that amount, sometimes it will be more, sometimes it will be less, but these are the real figures Katie and I have seen over the years we have been investing. If you want to rerun the numbers being more conservative, you are welcome to!

Comparing the two scenarios after 13 years and 4 months:

• Paying down the mortgage: You would have saved £60,000 in interest and own your home outright.
• Investing: You would have an investment worth £195,582, which is significantly more than the interest saved, and still have 6 years and 8 months left on your mortgage.

If you continued to invest for the full 20 years, your investment could grow to approximately £438,976 – far exceeding the total mortgage payments. You have to remember in this situation you would have paid £116k in interest so the difference is only £312k. Still not bad though!

Critical: Please note that this is a simplified example and actual investment returns can vary. It’s important to consider your personal financial situation and risk tolerance when making such decisions. Although Alan generally thinks risk is over simplified.

The maths of investing and compounding can far outweigh the interest on a mortgage. No one considers this when making the decision. They just repeat the rhetoric of “nothing feels like having a paid off house”.

I know Katie and I preferred having a shit tonne of money in our investments rather than a completely paid off property!

This is where the home lovers come in and say yes this is great Alan but house prices ALWAYS go up.

Do they? Our example above hasn’t taken into account housing prices going up and in general they do. In some areas far more than others.

If you had a 2 bed terraced house in Yorkshire and you bought it in Dec, 2007 you would have paid (on average) £150,876 and fast forward to now and your house would have gone up a whopping £6,556 to £157,432. Yippy!

We bought our 2 bedroom apartment in Basingstoke, Hampshire for £170,000 and sold it for £240,000 over 10 years later, making “£70,000. You might be thinking “that’s more like it!”

What Katie and I realised is that house prices are irrelevant in the decision to pay off the mortgage or invest. In both scenarios you would have benefitted from the increased house prices. In fact in the scenario where you put your money into the market and stay leveraged you would have made a far higher % profit on the house increase compared to the money you had in it.

House prices are irrelevant to our comparison because in both scenarios you own the house and get the increase.

Of course there are some HUGE caveats we need to consider in this decision:

1. Emergency Fund : if you don’t have a decent emergency fund to protect you if you lose your job, car blows up or whatever else the universe decides to throw at you then you are leaving yourself open to huge risk and having to potentially sell investments when they are down.
2. Job Stability: if you have a stable job (you work for the government), and you are doing well, then you can be open to investing. If your job is precarious and you aren’t confident in getting another if needed, this would absolutely affect my decision.
3. Good with numbers: are you good with numbers? Are you able to do the maths and work these numbers out for yourself? If not come on Rebel Finance School and we will show you how. Or sign up for Katie’s beginners guide to Spreadsheets and work on your number skills. You need to understand the maths!
4. Giant Gap: If you’ve crafted a chasm between your earnings and expenses, then you’re in the perfect position to invest as you have space. If you are cutting it to the bone every month and don’t have much of a gap then you might make a different decision.
5. Stress Testing: have you done the numbers to make sure that if interest rates do go up you can still cope? You need to be prepared for whatever the market throws at you.

We have looked at the two forces that control your decisions; Maths and Emotion. We have looked at the arguments for paying off your mortgage early. We have looked at the arguments against paying off your mortgage early and a mathematical example.

It comes down to the question “how much is the sense of security of having a paid off house worth to you?” Would you be willing to be £200,000 worse off but have a paid off home?

Would you be willing to be £300,000 worse off and have a paid off home?

How much are you willing to pay for that sense of security that people so highly prize from having paid off their mortgage? Are you aware of the risks of your strategy to pay off the mortgage that might leave you with little to retire on?

As always the Donegans want you to make your choice from a place of knowledge rather than a place of rhetoric, stories and societal beliefs, which are not based on maths and fact.

Run your own numbers. Do the maths. Work out what the impact is and which you are willing to do. The maths will affect the emotion if you properly look at it before deciding.

We would love to know what you think. What have we missed from the article? What have we not thought about? Your comments make our content stronger and more powerful. Thank you for reading

Love

Alan and Katie