Is it better to pay off the mortgage or invest in your pension?

If you’re one of the many borrowers bracing for a remortgage or an investor considering tax-efficient investment options during the cost-of-living crisis, our snappy overview can help kickstart your plans.

Published on 13 Feb 20244 minute read

It is important to strike a balance between mortgage repayments and pension investments if you can, while considering your personal circumstances and your plans for long-term wealth.

Why are mortgage rates so high right now?

Mortgage rates and other borrowing costs have shot up since the Bank of England (BoE) began hiking interest rates in December 2021. Loan rates continue to rise making it hard for households with heavy debt to stay on track
Interest payments are likely to jump when it’s time to remortgage, though the situation would have been much worse if you had to remortgage last summer
The full effect of the BoE’s 14 rate rises in under two years is yet to filter through. The rate on the outstanding stock of mortgages saw an increase in December as more people switched onto more expensive deals, highlighting how many existing borrowers are still on lower rates secured before the rapid rate hiking cycle began

Good to know – As the UK adjusts to rocketing borrowing costs, many homeowners and first-time buyers are mulling over their mortgage options. Take a closer look at the straightforward solutions from Bestinvest personal finance analyst, Alice Haine to help keep monthly mortgage repayments in check.

What happens when you invest money into your pension?

Pension contributions from basic, higher and additional rate taxpayers receive an extra 20-25% in tax relief, which would be lost if you simply paid off more of your mortgage. Learn more about pension reliefs and allowances. It’s important to remember tax relief depends on your circumstances and is subject to change
Many employers match extra contributions up to a certain level, which you would not receive otherwise
Funds within your pension can achieve higher rates of return if invested wisely (although your investments can also go down in value as well, and you might not get back what you’ve put in)
Every pension contribution can make a difference, no matter how small, thanks to the snowball effect of compounding

Good to know – the Best SIPP is an award-winning, easy to use and great-value personal pension that gives you control over your retirement savings and investments. You can download our in-depth guide to the Best SIPP for no charge. It’s a good idea to make sure you’re comfortable with the extra control and choice SIPPS provide. If you don’t want to invest across different asset classes or don’t think you will utilise the investment choice SIPPs offer, then a SIPP might not be right for you.

Give your financial wellbeing the focus it deserves

For some people, knowing the bank owns more of your home than you do can cause financial anxiety, especially during uncertainty. It’s understandable to consider reducing mortgage debt so you can improve your financial wellbeing. However, it is important to understand that this could be at the cost of building up a sufficient pension pot to support you in later life
Replacing your rental expense with a mortgage is an important financial achievement. The next step is ensuring you are saving enough into your pension so you can enjoy your retirement
Paying funds into a pension offers better potential tax advantages thanks to automatic government top ups and employer contributions, but your money is locked away for a long period of time as you cannot access it until age 55 (increasing to age 57 from April 2028)
Paying off your mortgage can give you more flexibility in the medium term and help reduce your outgoings
Thinking long-term? You can usually withdraw up to 25% of your pension pot tax-free when you retire – you could also nominate a beneficiary to pass on your pension and help a loved one

A good way to gauge how different scenarios could affect you is to talk through your plans with a financial planner.

How Bestinvest can help you

At Bestinvest it’s easy to arrange a free coaching session with a qualified financial planner whenever suits you, with no ongoing commitment. You can talk through your plans, set achievable financial goals and decide what’s best for your money.