What is the financial difference between overpaying and investing?

Quick answer

Overpaying can reduce the interest you pay and clear the mortgage sooner. Investing may produce a higher value, but the return cannot be known in advance. A fair comparison follows both choices over the same period.

What happens when you overpay?

Your normal mortgage payment covers the interest charged by the lender and repays part of the amount you borrowed.

An overpayment is an extra payment on top of this. It reduces the capital, which is the amount you still owe on the mortgage.

Once the capital has been reduced, future interest is calculated on the reduced mortgage balance. This means less interest is added in later months.

Over time, this can:

• reduce the total interest you pay
• help you repay the mortgage sooner
• release your normal mortgage payment earlier

What happens when you invest?

Instead of paying the spare money into the mortgage, you invest it each month.

Your mortgage continues on its existing repayment path. You do not receive the certain interest saving that comes from reducing the debt with overpayments.

The money you invest may grow over time. The final amount depends on the investment return achieved, which cannot be known in advance and is not guaranteed.

A worked example

Suppose you have a £180,000 mortgage, a 4% mortgage rate, 25 years remaining, a £950 monthly mortgage payment and £200 of spare money each month.

If you use the £200 to overpay, the model shows £30,159 less mortgage interest, the mortgage repaid 79 months earlier and the mortgage cleared about 6.6 years sooner.

At the assumed annual return of 7%, investing the spare cash from the start produces a modelled £164,055 at the actual baseline payoff horizon.

In each path, cash left after its partial final mortgage payment is invested at that month end. The mortgage-first path then invests the full monthly budget until the same horizon, producing £115,628. The separate interest saving is not added again.

Under these assumptions, the investing path produces the larger modelled terminal amount by £48,427. This is not a personal recommendation.

What could change the result?

A higher mortgage rate increases the value of overpaying.

A higher investment return increases the possible value of investing, but that return is uncertain.

The result can also change if you alter the amount paid each month, the mortgage term, the mortgage payment or the assumed investment return.