What does Mortgage Neutral mean and could it be the plan for you?
A different approach to overpaying your mortgage
Hello fellow Protagonists,
I recently joined a new group on FB based around Financial Independence in the UK.
My first question to the group was as follows:
"What age did you become mortgage free and what kind of impact did this have on your life afterwards? Was it totally worth it or did you regret focusing too much on it?"
One of the first responses back to this question after a mere handful of minutes sparked an interest.
They discussed not being mortgage free, but mortgage neutral instead.
Mortgage neutral is when we have enough money earning interest in a different account that could pay off our remaining mortgage if we wanted to.
So let's say we owe £100,000 on a mortgage and currently have an interest rate of around 2%, which is quite normal at the moment. The argument is that placing this money into accounts such as investment accounts could bring a far higher rate of return than 2%. This depends if you know what you are doing and using the correct investment strategies.
History would tell you that you are right to assume more than a 2% interest on average. But who can trust the past?
To further develop on this, we are going to assume a few more bits to tell this full story.
That we have 20 years left on the term of our mortgage
That the % doesn't change through this period
That we have £500 a month to play with
That we could earn a conservative 5% on investments
A small bit of maths could show how a mortgage neutral approach can work.
£100,000 at 2% over 20 years would mean we end up paying the mortgage provider £121,429 in total. £21,429 in interest if we never made an over-payment.
If we now apply that £500 over-payment from the beginning this would save us around £12,000 in interest and would also enable us to pay the house off 10 years, 11 months earlier.
In theory taking a mortgage over-payment approach would leave us mortgage free in 9 years time with no additional investments on the side.
So let's see where we could end up in 9 years time following a mortgage neutral plan and placing our £500 a month into a 5% investment account instead.
After 9 years of no over-payments we would have paid off £40,100, still owing £59,900.
Our Investment account at 5% annual return would now have £68,338.50.
£68,338.50 - £59,900 = £8438.50 more to our net worth than simple over-payments after 9 years.
The idea is that we could then either pay our mortgage off or continue to leave it in our account, hopefully continuing to grow.
Paying off the mortgage could save us £1,143.79 in year ten that would have been additional interest on the remaining balance for the year.
Leaving the £68,338.50 in the hope of another 5% interest would make us £3,503.54.
Potentially being a £2,000 difference in that one year alone.
Remember that this is not costing us any more to do so, it is just placing our money somewhere else.
So why not just go for this if it could make us more money?
Well, despite the numbers there is a key piece of information missing and that is... What feels right for us.
Some of us will get a sense of freedom from paying the mortgage off even if investing could bring us more money.
Mortgage neutrality is just another option that maybe we have not thought of before but once we know what our options are, we can at least then decide what is right for us.
We could even do a mix of both tactics, such as investing whilst on a fixed mortgage deal and then chunking an over-payment from those investments before moving onto the next fixed tariff.
As someone who is interested in both being mortgage free but who also loves investing, maybe the mixed approach could fill that gap.
Unfortunately life is more complex than the figures used for this example. Mortgage rates could shoot up, investments can decline in value, incomes can change, and inflation is a ball-ache.
Also, a thank you to Financial Independence UK for continuing to spark good discussion topics and having an active community.
GLHF (Good Luck Have Fun)
Contact me on Thedailybuff@gmail.com
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