Should I make extra payments on my mortgage?

In this article we are addressing a question we are frequently asked- whether, if you have the means, you should pay down your mortgage faster or not.

There are many variables to consider, and not surprisingly, the answer may not be the same for everyone.

Let’s paint a picture first:

• You are an expat, living in the EU, living outside your home country, and are not sure where you will end up in the longer-term.

• You purchased a property in the last 5 years with a mortgage as your primary residence, i.e. it is your home.

• You own about 15% of the property, meaning your mortgage is worth approximately 85% of the current value of your home.

• You pay off your mortgage monthly with payments that are principal and interest. This means you pay off the interest accrued in the month prior, and some of the capital. Over time the amount of interest paid back reduces proportionately, ever so slightly, every month.

Some quick numbers for illustrative purposes:

• Property value - €500,000

• Mortgage - €425,000

• Equity - €85,000 (the amount you own)

The situation arises where you have excess cash available.

You identify your options are to put it in the bank, invest it, add it to a pension (if permitted), spend it, or pay down your mortgage. You therefore ask us the question, what should you do?

We will often answer this question with more questions because there are financial and non-financial factors to consider.

Before considering more ‘exciting’ options, we will first recommend you check the foundations are in place. Do you have your short-term cash coverage and your emergency reserves? If you do not have a cash reserve in place, this can be an opportunity to implement this financial planning fundamental and in doing so give you some peace of mind.

Beyond the basics, the next concept to consider is opportunity cost.

Opportunity cost means if you do one thing with your money, such as pay off your mortgage, you cannot do something else, eg take a holiday. It is important to consider the various opportunity costs. The cost of taking one action is that you cannot take another action. It is a worthwhile exercise to stop and write down the opportunity costs, or what else you could have done, when deciding on how you might allocate this excess money.

Reflecting on the opportunity costs can make you critically assess your priorities and what is most important for you. This exercise will either reinforce the path you were considering, strengthening your decision making, or lead you to another option. In either case, the process will have been worthwhile.

Having weighed up the options and the opportunity cost of one path versus another, there are some specific elements you should also consider before making a decision. Moreover, we often remind clients when it comes to your primary residence- your home- it is not just an arithmetic exercise calculating numbers, there are non-financial impacts that should be considered. We will address these later.

Liquidity.

Liquidity is how easily you can get your hands on your money if you need it. Is getting access to your money important to you, or are you confident to have this amount put away for a long time? A good example is adding to a pension where you know you will not be able to access those funds for many years into the future.
When you pay down an extra amount on your mortgage, it often becomes illiquid. Therefore, you cannot easily change your mind and take that money back again. To do so you would have to apply for a new additional mortgage with all the associated costs or sell your property.

Divisibility.

This is linked to liquidity, but specifically accessing part of your funds. if for example, you paid down an extra €50,000 against your mortgage, could you access €10,000? Most lenders will say no. Divisibility, or in the case or real estate, indivisibility, is the fact that you cannot sell part of your property to access funds.

Interest rate / return on investment.

This is one of the key influencing factors in the decision. The interest rate of your mortgage, whether it is fixed or flexible, and its relation to prevailing rates will influence your decision. If you have a mortgage fixed at less than 2% per annum, and you believe you can get a return on your money that is greater than 2% per annum, then you may wish to invest it rather than paying down the mortgage. This gets complicated by the non-financial factors though.

Non-financial

The leading non-financial factor is peace of mind. For many, knowing they have a reduced mortgage provides a boost to their wellbeing that outweighs the opportunity cost of a higher return on their money elsewhere. When you consider that your primary residence is also a lifestyle asset as well as an investment, non-financial aspects cannot be ignored.

Finally, and probably the most important consideration is to assess how this decision of whether to pay down your mortgage or not aligns with your objectives. Was this one of your important goals and what impact will it have on your financial plan?

 As you can see, we like getting these types of questions from our clients, but the advice we provide and the answers we offer are much more complex than just the current interest rates. Accordingly the answer for one person may be different from the next and there is no absolute best course of action.

We will be very happy to help you make this analysis and guide you in the direction that is best for you. You can contact us at info@blackswancapital.eu – make an appointment and speak with us.