We cannot decide what to do with this money: should we pay off our mortgage (which is a tracker on a low interest rate) or not? If not, we are not sure what we should do with the money. We are both risk averse, we have been burned in the past from investment in shares and funds, so we don’t want to invest in these again.
The money is currently sitting in a bank account, effectively losing value every day – our mortgage interest is far more than the interest our money is earning on deposit. What is your advice?
Mr T.O’S., email
This is one of those eternal headwreckers. You have cash in hand but any borrowings you have are relatively low cost. What to do? And the truth is that there is no black and white answer. It depends…on you.
The first rule of balancing your personal books is that you use any resources that come your way to pay off debt before investing in savings. Like most rules, it is pretty grey: we invest in pensions, for instance, even while we owe money. And so we should as the tax benefit on pension savings is far higher than the benefit of paying off all but the most expensive forms of debt.
Still, as a general principle, it’s not a bad rule of thumb.
However, the second general principle of personal finance is that mortgage borrowings will, as a rule, always be the cheapest debt you incur. Mortgage rates on home loans are always lower than the interest rate on other borrowings, such as term loans for cars or home improvements, overdrafts or credit card debt.
Common sense says that you pay off more expensive debt – including any outstanding balances on credit cards – before entertaining the idea of paying off a mortgage.
And that’s even more true when you come to tracker mortgages. An old advertising campaign revolved around people’s lack of awareness about what a tracker was: precious few people are in the dark now after the tracker mortgage scandal where pretty much all of Ireland’s retail banks were involved in ripping off more than 40,000 homeowners by either denying them a tracker rate at all, or by cheating them with an incorrect, higher interest rate than the one that should have applied.
The reason they did this, of course, was that they found they were losing money on trackers and wanted to try to improve their profit margins. The fiasco cost the banks €710 million in payouts and well over €1 billion if you include their own administration costs.
So, a tracker mortgage is very much the cheapest money you will ever borrow and not something to easily give up.
You really have two decisions to make here: first, is it likely that you will incur borrowings for something else over the remaining lifetime of the mortgage? If so, you run the risk of losing access to your cheap mortgage funding by paying it off only to face a higher bill on a separate loan.
It would make sense in those circumstances to try to invest the proceeds of the investment property sale for use down the line rather than borrowing what will likely be a multiple of your tracker mortgage rates.
Term loans are currently charging from 6 per cent to about 14 per cent depending on who you borrow from, how much you need and over what term you intend to repay it.
But that brings us to the second part of the equation: where to invest?
And this brings us to the crux of the issue. Investment returns are at historic lows – or at least the returns on safe investments.
Demand deposit accounts are offering no return at present – 0.1 per cent per annum at best, and that’s before tax which will take a third of that miserly sum for Revenue.
Accounts that require you to give some notice before taking your money are little better, at 0.15 per cent before DIRT. And even a term deposit is giving you a return of just 0.3 per cent annually over three years and just under 1 per cent a year over five years – again before tax.
At least inflation is not an issue right now – it’s been running in negative numbers since the Covid crisis erupted – but it will return once the pandemic passes and will further eat into the value of your funds.
The best no-risk option right now is State savings through An Post. Five-year Saving Certificates offer the same 0.98 per cent annual equivalent rate of interest as the banks but there is no tax to pay. The 10-year National Solidarity Bond pays about 1.5 per cent a year over the full term.
At best, over the decade – assuming you can commit to keeping the money locked up – you might keep pace with inflation.
The truth is, of course, that returns are risk-related. The higher the risk, the higher the potential return. If you are not happy to entertain risk, you are going to be extremely limited in your options.
But, as you found out previously, if stock or unit funds move against you, you can quickly lose not just any gains but even some or all of your capital.
However, the nest egg for which you are examining options came from the sale of a residential investment property, so you clearly have some appetite for risk.
The question is how much. Do you prefer physical assets like property, art or precious metals over financial instruments?
All still carry risks. As any property investor over recent years knows, property prices move in cycles. Prices have risen in recent years since the financial crisis but they are only recovering lost ground.
The outlook is clouded by Covid and its economic fallout. With supply limited, property prices may well rise in the short term but the longer term outlook depends on many factors.
The same swings and uncertainties apply to art – a very particular niche – or precious metal, like gold, which is already trading at or close to highs.
How long you intend to invest for is another factor: longer term investment tends to allow time to smooth out slumps and peaks.
And speaking of longer term, it may make sense to use the money to boost your pension savings and benefit from the attendant tax relief.
The bottom line is that if you are reluctant to take a risk with this money, and you do not intend to borrow in the medium term for other projects, it might well make sense for you to pay down your home loan. As you say, you are currently paying more in interest even on your tracker home loan rate than you are receiving from the bank in interest on your savings.
But it might make sense to talk to a financial adviser first, someone who can talk you through the potential and the risks of various investment choices. As we enter a new, and hopefully less fraught, year, that would also allow you the opportunity to assess your wider financial position including retirement savings. Spring-cleaning your personal finances is never a bad idea.
Please send your queries to Dominic Coyle, Q&A, The Irish Times, 24-28 Tara Street, Dublin 2, or email email@example.com. This column is a reader service and is not intended to replace professional advice. No personal correspondence will be entered into.