When you hit a six-figure income, you may begin to consider overpaying your mortgage.
The idea of paying off this loan early can be tempting, but did you know it may not be the most tax-efficient use of your money?
The key question remains: should you overpay, or invest in your pension? In this article, we’ll explore the choices available to you. So, read on to find out more.
How much income do you need?
The first step to answer this dilemma, is to consider your mortgage. You’ll need to calculate how much income is required to make an overpayment, monthly or annually.
Wealth management and financial planning firm, Saltus, provide an accurate example of how much income you will need to over-pay £1,000 of your mortgage each month, or £12,000 a year. They explain that you would need to earn approximately £30,000 on top of your £100,000 income, in order to pay this amount towards your mortgage.
This is because of the tax that you will need to pay on your income above £100,000. You will be liable for national insurance, a higher rate of income tax, as well as losing your personal allowance (£12,570 of earnings that are free of tax).
When calculated all together, an additional income of £29,358.62 (on top of your six-figure income) will cost you £17,358.62 in tax payments, leaving you with the annual £12,000 you’d like to pay towards your mortgage.
If you apply this to a mortgage of £250,000, you’ll need a total of 21 years and more than £600,000 of income!
Evaluate your mortgage fully
It’s also worth consulting your mortgage provider, as overpayments could incur a further fee, and there may be limits to the amount that you can overpay. For example, fixed-rate mortgages tend to have an annual overpayment limit of 10% of your total outstanding balance. You can use an online mortgage overpayment calculator to help you roughly work out how much you can overpay by and how long it would take you to repay the loan in full.
Using your pension
If your’e looking into paying off your mortgage early, you may be better off taking that money and putting it into investments or savings.
One expert strategy to consider is to use the same amount that is required to overpay your mortgage, and contribute to your pension instead. But what is the benefit of doing so? Not only could you actually see yourself paying your mortgage off quicker, when you have access to your pension savings, but you would also avoid paying a significant amount of tax. If we use the same example as above, and an individual earning in excess of £100,000 paid the same £29,358.62 (on top of their six-figure income) into their pension, this would result in an annual tax saving of £17,358.62.
This is because pension contributions are gross of all tax and you would regain your personal allowance, due to your taxable income reducing to £100,000.
Depending on the amount of pension you have built by the time you can access it, you may in fact have the accumulated enough money to pay off the total amount of your mortgage. When you reach retirement age, you can access 25% of your pension savings completely tax-free. If you made pension contributions in this way, you could pay off a £250,000 mortgage (using your tax-free cash), 13 years faster than making overpayments and you’d save over £360,000 in tax.
If you are earning in excess of £100,000, seeking advice on your pension and financial planning could be a better option than deciding to overpay your mortgage.
Disclaimer: Information is correct to the best of our understanding as at the date of publication. Nothing within this content is intended as, or can be relied upon, as financial advice. Capital is at risk. You may get back less than you invested.
