Paying off you mortgage early…options for reducing the interest and the term of your biggest debt
Being in debt forever has become a real possibility for homeowners with the launch of the UK’s first never-ending mortgage. But for many people, a mortgage remains a huge psychological barrier standing firmly in the way of ultimate freedom.
Without winning the lottery, paying off a £100,000 loan in two years will be beyond the means, as well as the willpower, of most borrowers. You could work 20-hour days and live off baked beans until the debt is cleared, but for most people this is totally unrealistic. However, there are less drastic measures that can make a big difference over time, such as mortgage deals specifically designed to reduce the interest and the term.
Offset mortgages, which enable borrowers to reduce interest payments by offsetting the loan against their savings, are starting to look more competitive. Borrowers who took out offset deals a few years ago paid a high premium but rates are now more in line with those on traditional loans.
Despite this, you still need to have substantial savings before offset deals become worthwhile. You need to have about approximately 8 per cent of the outstanding mortgage amount in savings before considering offsetting.
On a £150,000 loan with an interest rate of 5 per cent over a 25-year term, offsetting savings of £20,000 would save £40,000 in interest and clear the mortgage three years and eight months early. With a savings pot of £50,000, the term would reduce by seven years and two months, saving £77,000 in interest.
The advantage of keeping the money in savings instead of using it to pay off the loan directly is that you have access to it for other purposes.
Another option is a fully flexible deal that does not have early repayment charges and allows unlimited overpayments, underpayments and payment holidays. These are also becoming better value. By overpaying regularly, not only are you reducing the capital, but you are reducing the interest that you have to pay.
On the same loan given in the example above, overpaying by £200 a month would save £38,000 in interest and clear the mortgage seven years and six months early. Increasing the overpayments by an extra £100 a month would save a further £10,000 and cut an additional two years and two months from the term.
However, most mortgages allow overpayments of up to 10 per cent of the outstanding amount, or the original loan size, without incurring a penalty. The advantage of using the 10 per cent facility instead of a fully flexible deal is that you tend to get slightly better rates on standard residential deals.
If you do not have savings or are not in a position to make regular overpayments, there are other ways to reduce your loan. For instance, by remortgaging to a cheaper deal and keeping your repayments the same, you effectively overpay without increasing your outgoings. This is a good option for borrowers who aren’t on best-buy deals. They start overpaying without feeling any difference.
Not everyone should consider mortgage overpayments as a top priority. People need to view their finances, including their mortgage, in a holistic way. There is no point ploughing all your spare cash into mortgage repayments if you have other debt, such as credit cards or personal loans, with higher rates. The rule of thumb should be first to repay the debt with the highest rates.
Although terms longer than 25 years sound terrifying, they can be a sensible temporary option for those who need to reduce monthly outgoings for a while. Repayments can then be increased when other debts are cleared.
There is no magic reason why a mortgage term should be 25 years. It used to be suitable for people taking out endowments. But it’s a different world now.
If you would like to discuss your specific property requirements with us please e-mail or contact us to arrange a meeting.
Your property may be repossessed if you do not keep up repayments on your mortgage.
For mortgage advice you can choose how we are paid: pay a fee, usually 0.5% of the loan amount, or we can accept commission from the lender.
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