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| Your tax position is likely to
make this a good use of savings. |
The economics
There is no tax relief on mortgage payments. Put this another way:
you pay mortgage interest out of taxed earnings.
If you invest in a deposit account you will pay tax
on the interest. So, to compare one with the other you will have
to 'gross up' the mortgage interest rate at your marginal tax rate.
Best to do an example:
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example..... |
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You are a higher rate (40%) taxpayer with a
mortgage at 6%. If you have £10,000 saved and you use
it to repay part of your mortgage you will save £600
per year. If you place it on deposit at 6% you will earn £600
gross less tax of £240, equals £360. Better to
save £600 than earn £360.
Only when the interest rate on the deposit account
reaches 10% will you break even. 10% is 6% 'grossed up at
40%'.
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In this example, 10% interest on a cash deposit account
is a pretty compelling proposition.
Points to watch
These may affect your decision:
- Your mortgage may have early repayment penalties.
- You may have a fixed rate mortgage that now
looks pretty cheap (but just do the maths).
- Cash is king. If you need money it's not
as easy to remortgage as it is to take money out of a deposit
account.
- As a mortgaged homeowner you are a member
of a politically powerful group. The government cannot allow anything
too nasty to happen to you (as a group).
Our advice
You will have your own tax and mortgage interest position to consider.
But for many people mortgage repayment is likely to be a good use
of savings. We recommend that early mortgage
repayment is a good working assumption until you can prove to yourself
that you have a better use for the money.
One way of testing this is to work out your grossed
up mortgage interest rate (10% in the above example) and carry that
forward into the Simple
Investing module. This will lead you through a 'What Assets?'
decision process where you can include a 10% (example) deposit account
as an option.
What next?
That's the last step of the 5/95 plan. You have arrived at a set
of financial decisions that seem sensible. What you have not done
is to peer into the future to see the consequences of those decisions.
Nor have you learned how to invest any surplus savings. To do either
of those things you must move on, in your own time, to saving, investing
and planning.
| Move to the next Foundation
step: |
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Saving |
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