Whether to save for a house deposit or start investinf in the stock market is a dilemma every financially savvy person will ask themselves at some point during their personal finance journey.
Broadly speaking, investing in equities (stocks and shares) is expected to produce higher returns than real estate but typically involves a greater level of risk. However, saving for a house deposit and purchasing a first home is a significant life moment and prevents “wasting” money on rental payments.
Whether you decide to use your surplus (difference between income and expenses) to save for a deposit on a home or to invest in the stock market, the rest of this article will help answer all common questions and help you figure out the best route for your circumstances.
Should I focus on investing or saving for a house deposit?
For many, saving for a house deposit and ultimately owning your own home is an important rite of passage. For others, purchasing a home is less important and they prefer to use spare capital to invest in the markets. Ultimately, this is a personal decision depending on your financial goals.
Benefits of investing in the stock market:
- Your money will compound over time (earn returns on previous returns)
- You are likely able to earn higher returns than other asset classes are able to provide
- Your money will not be sat in a low-interest cash account being eaten away by inflation
- You own small pieces of all of the worlds most valuable companies
Benefits of saving for a house deposit:
- You will own a property so won’t “waste’ money paying rent
- Mortgage payments increase the equity in your home so each payment doesn’t decrease your net worth as it does with rent
- Purchasing a home is an important rite of passage for many people
- Owning a home gives you flexibility to change it as you see fit which is rarely the case with rented accomodation
- Owning a property can provide great returns if your property appreciates in value over time
Whether to invest or to save for a house deposit is not a purely financial decision. Many people choose to purchase a home not simply because it is better for their finances but because it gives them a sense of permanence, community and flexibility as they are able to decorate and alter their home as they desire.
Is paying off your mortgage better than investing?
Paying off your mortgage instead of investing is unlikely to be a financially sound decision. In the UK, most mortgages are at low rates of interest so paying this down saves you a few % of interest a year which is typically less than a broad stock market index fund will return on average.
Take the following example, let’s say you have £50,000 left on your mortgage which has an interest rate of 3% per year and you have an investment account investing in the S&P 500 which typically earns around 10% on average per year (although fluctuates year to year).
If you had £50,000 to spend, which is the optimum choice? Well, by paying off your mortgage early, you would save the 3% of the interest accrued in the year assuming there are no early repayment penalties.
3% * £50,000 = £1,500. So by paying this mortgage off early, you have saved yourself £1,500.
However, if you invested the same £50,000 in the stock market and it returned an average of 10%, you would have an extra £5,000 of wealth (£50,000 * 10%).
Clearly, the £5,000 wealth created is superior to the £1,500 in interest saved.
As with all things, the decision is rarely purely financial. Many people decide to pay off their mortgage early (even if the money could be more efficiently allocated to investments) for other reasons.
For example, perhaps the family just wants to get out of any form of debt or had a goal set to have paid off their mortgage by a certain age.
What’s a better investment: your first home or stocks & shares?
Investing in the stock market is a better investment than purchasing your first home. Whilst certain homes appreciate rapidly and outstrip the returns offered by stocks, this is not the case on average. Most people purchase their primary residence as a dwelling not as an investment.
When most people come to buy their first home, the investment potential is typically an afterthought. Sure, most people would like a house that they can ultimately sell on for a profit but this typically falls behind over considerations like living in a nice area, having access to good facilities and schools, closeness to family and friends etc.
Real estate can be a profitable and smart asset class to invest in but this is typically done in the form of an investment property (where you purchase a property to rent it out to tenants) or via an investment vehicle like a REIT whereby you purchase units in a fund which directly holds properties.
For those purchasing their first home, the property itself is usually not a good investment in comparison with a broad stock-market fund because it wasn’t bought with the sole intention of earning income and returns over time.
The stock market is generally considered riskier but with a higher expected reward than real estate investing and this is especially the case when it comes to real estate bought to live in, not to rent out for income.
How much could I make if I invested my home deposit savings in the stock market instead?
If you had saved a £50,000 sum for a home deposit, this amount could grow to over £850,000 if it were held in the stock market over a 30 year period (assuming 10% returns a year). This wealth creation opportunity should be seriously weighed up against the benefits of homeownership.
Using a simple future value calculator, like the one here, you can see how much your home deposit amount could turn into over time whilst adjusting variables like time period and expected annual returns.
Assuming a 30 year time period and average annual returns of 10% per year, the following home deposit savings shown in column A would grow to the investment values shown in column b if invested in the market.
| Home deposit value (£) | Future expected investment value if invested in stocks for a 30 year period (£) |
| £20,000 | £348,988.05 |
| £30,000 | £523,482.07 |
| £50,000 | £872,470.11 |
| £100,000 | £1,744,940.23 |
The point being made here is that significant sums of money (as you may have when making a house deposit) invested into the stock market over the long term can produce life-changing levels of wealth. This should be seriously considered when deciding if purchasing a home is the best choice for you.
How much do I need to save for a £300,000 house?
You will typically need a deposit of around £30,000 to afford a £300,000 house with a 10% deposit being fairly common. This relies on being able to borrow the remaining £270,000. A mortgage worth 5* your annual salary is usually offered to those with a stable job and good credit history.
There are a number of factors to consider when determining how much of a house deposit you need to save. Obviously, the total value of the house itself will be fundamental. House deposits are typically anywhere between 5% and 20% with the remainder of the house funded by a mortgage loan.
As a rule of thumb, you can typically get a mortgage of 4* or 5* your total gross salary. So if you earn £50,000 per year you could expect to be able to borrow an amount of £200,000 – £250,000 in the United Kingdom.
Should I pay off my mortgage early?
As mortgages tend to be accompanied by very low-interest rates of only 1-3%, it often doesn’t make sense to pay off your mortgage from a purely financial perspective. The money spent paying off your mortgage could be invested in other assets and earn more than the 1-3% you would save on mortgage interest.
Paying off your mortgage is seen as a momentous moment in many peoples lives – finally freeing themselves from the years of financial obligation. For this reason, some mortgage holders decide to pay off their mortgage early.
There are some benefits to paying off your mortgage early. Clearly, you will save money on the interest that would have accrued had you not paid off the remaining mortgage balance. Psychologically, paying off your mortgage and getting to a position where you have no debt can be powerful.
However, there are a couple of downsides to early mortgage repayments. Firstly, you want to be sure that your mortgage does not contain early repayment penalties. Secondly, if you have a low-interest rate on your mortgage, the money you are repaying may be more effectively allocated to investing.
Do early mortgage repayments harm your credit score?
Paying off your mortgage early will not have a significant impact on your credit score. It is unlikely that early remortgage payments will either increase your credit score or decrease it. Once repaid in full, your mortgage will simply show as a closed account on your credit report with no issues noted.
Having a mortgage and ensuring you pay your monthly instalments on time and in full will have a hugely positive impact on your credit score as it shows you can successfully repay the debt over a long period of time without issue.
When you repay your mortgage early, the mortgage debt will simply present as a closed account with no noted issues on your credit report. Repaying early won’t necessarily improve your credit score as it doesn’t demonstrate you are able to reliably repay debt, it just shows you repaid this one debt early.
This may be due to having the financial means to do so but you could have just won or been gifted the money.
If a mortgage is the only example of periodic debt repayment you have (i.e. no car payments or phone bill), repaying your mortgage early may even have a marginal negative effect on your credit score but this is very unlikely to have a significant impact on your ability to borrow in the future.
Is owning a home considered an investment?
Owning a home is not typically considered an investment as the primary motivation for purchasing the property is often not for the financial benefits. However, many properties do appreciate in value over time and this is something many homeowners consider prior to purchasing a home.
One interesting point to consider when beginning to invest is your exposure to each asset class (stocks, bonds, cryptocurrency, real estate etc). If you hold a large amount of equity in your home, your exposure to ‘real estate’ as an asset class may make up a significant proportion of your total investments.
As such, investing further in real estate via REITs or investment properties may over-expose you to this asset class and prevent diversification between asset classes with different levels of expected reward, risk and protection against inflation for each.
What is an ‘investment property’?
An investment property is a building you purchase with the intention of renting it out to tenants to earn income. The rental income earned expressed as a percentage of the purchase price is known as the “yield”. An investment property is one way of getting exposure to the real estate asset class.
Crucially, an investment property is not a property that is also your primary living residence. The significant point is that the property is only purchased and owned with the express intention of letting it out to tenants to earn income and return on investment (ROI) on the initial money spent purchasing the property.
Is an investment property a better investment than stocks & shares?
In terms of return on investment, using a stock market proxy like the S&P 500, investing in stocks will likely provide higher returns than the vast majority of investment properties will yield. Stock market investing is often less hassle than purchasing and maintaining an investment property.
An investment property can be a great investment and can earn returns in two distinct ways. The first is yield which is simply annual rental income over the total purchase price of the home. For example, if you buy a house for £300,000 and rent it out for £15,000 a year (£1,250 per month), the yield is 5%.
The second way of earning returns on an investment property is capital appreciation. If your £300,000 property appreciates in value to £400,000 after 10 years, you have earnt £100,000 in the period, or £10,000 per year which can be realised if you sell the property.
Despite this, investment properties typically yield less than a stock market proxy like the S&P 500 will return on average.
On top of this, investment properties are far more frictional than stock market investing which is very low-effort and can be automated in full.
Investment properties require physical maintenance on the property and relationship maintenance with the tenants who can cause damage or not pay their rent on time.
As always, please remember I am an Accountant, but not your Accountant. In this post (and all of my others) I share information and oftentimes give anecdotes about what has worked well for me. However, I do not know your personal financial situation and so do not offer individual financial advice. If you are unsure of a particular financial subject, please hire a qualified financial advisor to guide you.
This article has been written by Luke Girling, ACA – a qualified Accountant and personal finance enthusiast in the UK. Please visit my ‘About‘ page for more information. To verify my ACA credentials – please search for my name at the ICAEW member finder. Please comment below or contact me here to get in touch with questions or ideas for future posts.