Today we learned that we’ve cleared 60% Loan To Value – so we’ve stopped making mortgage overpayments on our house. Here’s why.

Why we were overpaying on our house

I wrote a post about this previously, cunningly titled Why I overpay my mortgage AND have an investment portfolio, but here’s a shortened summary.

Houses: assets or liabilities?

As I alluded to in my post on how we became accidental minimalists: a house isn’t necessarily an asset.

I mean, sure – living in a house is 100% better than living on the street. I’m grateful! That’s not really my point, though: a house doesn’t generally put money in your pocket.

There are exceptions, such as using a house to borrow against (i.e. remortgage to “free up” cash in an “equity release”). Those notwithstanding, if you’re living in it and you’re not using it as a base for business or for lodgers or something, a house isn’t really a financial asset.

This is because the value of the house actually doesn’t help you if you plan to live in it.

You don’t benefit more by having a £600,000 one-bed flat in London than by having a £200,000 two-bed in Leeds, not when it comes to keeping you warm and dry. This was a big part of my argument as to why net worth sucks as a financial independence measurements. That £600k one-bed isn’t more waterproof because it’s valued at three times the price.

In my head, a house is a liability. A necessary liability perhaps, like eating and drinking, but still a liability. It’s a cost.

Paying down debts

There’s allegedly a difference between good debt that’s used to buy assets and bad debt that’s used to buy liabilities.

With houses it’s less cut-and-dry, because the debt is quite cheap. Secured loans, like mortgages, are generally cheaper than unsecured loans. Cool. If houses are liabilities though, surely mortgages are bad debt?

We took the approach that mortgages are generally bad debt on your home. That said, because they’re currently inexpensive at 2% or so, it doesn’t make sense to pay them off too quickly as you can probably earn more than that in returns from other assets, like shares.

Unfortunately, most of the world seems certain that mortgages will remain this cheap forever. We’re less certain.

We had locked in a 5-year fix at a little over 2% a couple of years ago. This is because we didn’t think the London bank rates would be consistently below the 0.5% we’d mortgaged at for as long as they have (I mean, who saw COVID coming?!) and when you factored in the remortgaging charges every 2 years to secure a better deal we were better off committing for 5 years at a slightly higher rate.

We planned to live here forever, so this was a debt we knew we’d be paying someday!

The idea was that by making small mortgage overpayments, we would drop below the magic 60% LTV line. I guess that needs more explaining.

Loan-To-Value (LTV) and mortgage overpayments

When you buy a home or mortgage an existing property, the bank bases its offer on LTV.

LTV is effectively a ratio of the house that you own versus the ratio that you are letting the bank take if you fail to pay the loan. Seriously, that’s it.

So, 90% LTV means that you have paid in 10% of the expected sale value of the house/flat. The bank has paid in 90%. That means if you go bust, the bank might sell the property and would expect to keep 90% of the predicted value of the property.

Foreclosures are quite rare in the UK thanks to a lot of legislative protections. However, when they happen, banks aren’t interested in becoming landlords. They’re not set up for that. Instead, they look for a quick sale, so your £200,000 house might only fetch £180,000 in a rushed sale.

Wait, that’s 10% under the value… well, the bank will let your share take that hit. Seems like you have zero and the bank has its £180,000!

Obviously, these numbers are neat: the bank might only get £170,000. It might be lucky and get full asking price. Who knows?

The point is that the bigger your share is, the bigger their safety buffer is if they need to sell up because you won’t pay. So, a lower LTV is safer and happier for the bank.

Why LTV matters to you as a customer

Mortgages are offered in 5% or 10% LTV brackets, depending on your bank. If you have a better offer, they offer you a lower interest rate.

We found that at 60% LTV, there are no better offers. You can basically do what you want: renovate, pay the bare minimum… or switch to a buy-to-let mortgage and rent the place out.

Thus, our plan was to get to 60% LTV while still being within our 5-year fixed mortgage period. Which we hit. Nice!

The opportunity cost of mortgage overpayments

Mortgage overpayments are sadly not lucrative.

Let’s say out mortgage was offered at 2.4%, which is close to the truth. That means that if I made £100 in mortgage overpayments, I’d have the same rate of return as paying it into a savings account at 2.4%.

My mortgage still has, say, 25 years to run. Effectively, that’s 25 years of compounding. Over that time, the £100 paid now will take off £180.93 of debt at today’s rate. That’s… not bad!

But it’s nothing compared to earning even 5% in an ETF portfolio for 25 years, which would have a value of £338.64 by the end of the same period.

The opportunity cost of overpaying my mortgage by £100 at the 25 year point is therefore £157.71, at quite a conservative estimate. I.e. I could have had £338.64 of value, but if you take away the £180.93 of value I get, that’s a £157.71 deficit.

This is why I mainly invest my money, rather than overpay the mortgage.

Wait – if mortgage overpayments came with such a cost, why did you make them?!

Simple: we valued the potential freedom of having a better LTV sooner more than we valued having a larger portfolio value overall.

Not everything boils down to numbers and housing is just one of those emotional things.

I had assessed that £200 per month in mortgage overpayments would be the best compromise between achieving this 60% LTV and getting value from my investments.

Having hit 60% LTV, we can be confident of getting the best mortgage rates and preferential terms, and we have the option of renting our home out if we relocate. That’s a strong defensive and flexible position to be in.

Moving forward

We’re no longer making mortgage overpayments!

This frees up £200 per month in cash flow, which is quite nice.

Now, for reasons I’ll go into when I release the 2022 financial independence campaign plan, our situation has changed. Still, this puts is in a great position, and I can rest assured than my home is semi-safe for the time being.

Nice!

Anyway, short post this week after last week’s epic. We’re off to celebrate with a cheap wine over home-cooked dinner.