Finance: Mortgages
Tags: finance, mortgage, income
Published: 2023-10-23 11:56:30

What i suggest here may mean taking on a higher level of risk than you are comfortable with, so it is not for all, but it is one possible approach to repaying your mortgage.

## What

Don't pay as much income tax by paying into a SIPP and using your tax free cash from that SIPP to pay off your mortgage.

## Why

1. You can reduce your taxable income by paying into a salary sacrifice SIPP, this will reduce your income tax and national insurance liability. This means you will get perhaps 32%+ (20% basic rate tax and 12% national insurance) immediate benefit of paying into a SIPP over taking a higher salary, paying that tax and paying down your mortgage.
2. Investments in the stock market go up and down, but as long it goes up more than inflation (and the costs of the investment, such as fund fee or management charge of the platform you hold the investment on) an investment provides a positive return.
3. Every year your debt reduces in value by the level of inflation. i.e. your debt is worth less next year than it is worth this year - this is called the opportunity cost. 
4. Every year investments reduce in real terms value by inflation, but they are also increasing/decreasing in value as they are not of a fixed value like your debt (which does not actually change in value, but gets repaid if you make repayments, or incurs costs in the form of interest).
5. Currently you can take 25% of your SIPP's value at retirement as tax free cash, i.e. not pay income tax on it.

# How

Say inflation is 2%, which is what the bank of England try to maintain the UK inflation rate at. Each year you can expect the prices of goods go up on average 2%, your mortgage will be able to buy you 2% less in the real world (which is why things cost more and more in the shops each year), and thus if you have a £100,000 mortgage after a year of 2% inflation it is now only (real term value) £98,000. Debt can therefore be used to your advantage, and being in debt is not always a bad thing.

Compare inflation to the interest rate you pay to the bank, if the UK inflation rate is 6% and you are paying 4% to the bank you are (real term) earning 2% on the debt each year, and this compounds.

Typically you would expect inflation to be at 2%, you would pay a 6% mortgage and therefore the real term cost of the mortgage is 4% (not 6% like you may feel).

You will have to pay the bank to borrow that £100,000 and if you only pay the interest you will still owe £100,000, but next year your £100,000 debt is now worth 2% less, and the year after that your £98,000 (discounted value next year) is worth another 2% less i.e. £96,040, on paper it is still £100,000, but the real term value of that debt is less.

Owning mortgage debt is good as it is cheaper than credit cards / loans, but it carries risk; what if the bank increases the interest rate (borrowing cost) when your deal expires, or house prices fall or you can't afford the keep the debt? Or the price of your house falls below the amount you borrowed for it? Then you will need to unload the debt in some way - selling the house? Taking in a tenant? Getting another job? You need to ensure that you never over leverage yourself - which is the act of taking on more debt than you can manage, and hence the reason why people reduce debt. 

You are multiplying risk / reward by taking on debt.

## Why keep a mortgage?

Paying into a SIPP rather than paying off your mortgage provides a 32% immediate gain (savings on income tax + NI), and as long as the investments you select perform better than the cost of your mortgage your making a positive return. In addition to this, holding a larger debt until your tax free cash is released provides an additional return as your debt is decreasing in value over time.

## Why you shouldn't use a credit card

They cost far more than any investment will ever return to you and are a gateway to poor spending habits. Credit cards provide no benefit other than for helping you make transactions online.