Is it better to invest or overpay your mortgage?

For homeowners up and down the country, a dark cloud is looming on the horizon: their fixed-rate mortgage coming to an end.

Many of those on five-year deals would have been on interest rates under 2%, but face an almighty shock when they renew, with most five-year fixes now over 5%.

The average price of a UK property stood at £290,000 in March of this year. On a 2% deal over a 25-year term, that results in monthly repayments of £1,157.

But a 5% rate would see this surge to £1,697, with 6% – not totally out of the question – taking the mortgage to £1,867.

Confronted with the prospect of paying thousands of pounds extra a year, households are now trying to prepare.

Making overpayments before the renewal is one common strategy, as this will reduce the value of the loan by the time of the next renewal.

Putting cash aside in a high-interest savings account is another option, as these funds could be used to soften the blow of repayments when the bills go up.

And the final option: could opting for long-term investments in the stock market end up being a more prudent financial decision?

Here, we'll examine the pros and cons of each option.

The argument for overpaying

When interest rates are high, the Bank of England wants to make paying off debt more attractive – encouraging us to save rather than spend.

Overpaying your mortgage can be a smart decision if you believe that this will deliver a greater return than investing your money elsewhere.

It can also be worthwhile if – by the time you're renewing a fixed-rate deal – you're tantalisingly close to falling below a significant loan-to-value (LTV) threshold.

Generally speaking, banks and building societies reserve their most competitive interest rates for borrowers whose mortgage is worth less than 60% of the property's value.

This means that, if you're going to be on 61% LTV by the end of your current term, spending a few grand to get you to that 60% threshold could make a difference.

Away from talk about returns and repayments, it's also important to reflect on the psychological advantages associated with overpaying.

It can be incredibly satisfying to reduce debt – and feel like you truly own your home. And by eating away at your monthly bills, it leaves more disposable income to do the things you love.

It also helps reduce stress when times are hard – keeping a roof over your head more easily if you were to lose your main source of income, or hit financial hardship.

It's worth knowing, though, that many mortgages only allow you to repay up to a certain amount before you'll face an Early Repayment Charge (ERC).

The argument for investing

Everyone's circumstances are unique – the right answer will depend on your income, outgoings, the size of your mortgage, and how much of a risk you're willing to take.

But when weighing up whether to invest or overpay your mortgage, though, the most important factor is often your mortgage interest rate.

Generally speaking, the lower your mortgage rate, the stronger the case for investing.

When interest rates are low – say, 2% or 3% – it’s hard for overpayments to compete with the potential returns from long-term investing. In other words, you’re paying relatively little in interest, so your money could work harder elsewhere.

But at higher mortgage rates, like 5%, the decision is less clear-cut. 

Overpaying by £200 a month on a £250,000 mortgage at 5% would save you £44,480 in interest and shave almost six years off your mortgage.

If you invested that same £200 a month and achieved a 5% return, you’d finish up with £81,470 after 19 years and ten months – just enough to clear the remaining balance, and a few hundred pounds to spare (excluding any early repayment charges).

In this scenario, investing only pulls ahead if your returns comfortably beat your mortgage rate, which is far from guaranteed.

That said, we're assuming the returns you'd get from investing are comparable – and they often aren't.

Investors are often looking to achieve at least a 9% annual return. The S&P 500, for example, has delivered an average return of just over 10% per year since the 1950s.

If we run the numbers again and look at a 9% investment return, the differences are staggering.

This time, you would be £51,020 better off by investing rather than overpaying.

This is because you'd be able to pay off your mortgage after the 19 years and 10 months that an overpayment would take – and still have £51,020 left over.

Here's how a £200 monthly investment compares to a £200 monthly overpayment on a £250,000 mortgage, depending on your return and mortgage rates:

Investment return	3% rate	4% rate	5% rate	6% rate
3%	+£170	-£7,420	-£16,060	-£25,450
5%	+£17,070	+£9,130	+£310	-£9,430
7%	+£39,590	+£31,110	+£22,020	+£11,770
9%	+£69,770	+£60,500	+£51,200	+£40,010

And as our chart clearly shows, at a 3% interest rate, investing wins out every time – even if only by a couple of hundred pounds.

As mortgage interest rates creep up, though, the more vulnerable you are to losing significant amounts of money if your investments underperform.

In short – it's a gamble. Whether it’s worth rolling the dice depends on how comfortable you are with the idea that your investments might soar… or stumble just when you need them most.

The argument for saving

Last but not least, let's talk about why saving is an option that some people would consider.

Let's imagine that you've been aggressively overpaying your mortgage for the past five years through regular payments to your bank.

But then there's a huge setback: you lose your job – and the income to keep up with your bills.

You can't claim your overpayments back – you can't be reunited with that money.

By contrast, savings give you flexibility in the event that something goes wrong. If you're made redundant, you have a nest egg to draw from until you're back on your feet.

You can also use these savings to make repayments that little bit less painful after a renewal. And if your new fixed-rate deal doesn't end up being as terrifying as you first feared, this cash can still be invested or used for overpayments.

This is why it's crucial to try to build an emergency fund – and it's typically recommended you have three to six months of living expenses set aside. You probably shouldn't look to overpay your mortgage or invest if you don't have an emergency "rainy day" fund.

In fact, building an emergency fund came way ahead of paying off your mortgage when we examined the optimal order for investing.

However, looking at this through a lens that doesn't factor in emergencies or mental health, and only focusing on the numbers, saving cash – even in a cash ISA – would be a more expensive financial decision if your savings rate is lower than your mortgage rate.

If you put £200 a month into a savings account at 4%, rather than using it to overpay a £250,000 mortgage with 5% interest, you’d actually end up £8,450 worse off after 19 years and 10 months – the time it would have taken to pay off the mortgage with those overpayments.

A blended strategy

Of course, you don't need to put all your eggs in one basket by only adopting one of these strategies.

You could invest, overpay, and save all at the same time, with each in moderation.

And there are some products on the market that help you kill two birds with one stone, such as offset mortgages with savings accounts attached to them.

This kind of blended approach offers flexibility. It means you’re building up a safety net for emergencies, whittling down your mortgage, and still giving your money a chance to grow in the markets.

For many people, spreading things out in this way helps them to sleep more easily at night, knowing they’re not relying on just one outcome.

How do I know what's right for me?

Start by looking at your mortgage rate, your financial goals, and how much risk you’re willing to take. If your mortgage is expensive, the security of overpaying might appeal – especially if being debt-free sooner is a priority. On the other hand, if your rate is low, investing could offer a better shot at growing your wealth, provided you’re comfortable with the ups and downs of the markets.

But it’s not all about the numbers.

Think about how much flexibility you need, how stable your income feels, and how you’d cope if things didn’t go to plan. For most people, having an emergency fund comes first – only then should you think about overpaying or investing extra cash. And if you’re at all unsure, a chat with a qualified financial adviser can help you weigh up the options and avoid costly mistakes.

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