For many homeowners, paying off your mortgage is the ultimate financial goal. It’s no accident that ‘repay mortgage early’ is one of the most commonly entered financial phrases on Google.
Your mortgage is probably your biggest financial commitment. And with mortgage terms commonly lasting 25 years or more, you’ll end up paying enormous amounts of interest on the loan.
One way of shortening your path to financial freedom is to repay your mortgage early. This would then leave more cash in your bank account each month.
You must think carefully about when, and how much, you repay. Bear in mind you could end up paying thousands of pounds in mortgage early-repayment charges.
There are several overpayment mortgage calculators on the internet. Here is one example.
Let’s imagine you have a 2% rate on your repayment mortgage, with a nominal 21-year term. The repayment is £973 a month. You decide to pay an extra £100 a month for 10 years. You repay your mortgage 16 months early. This saves you £4,318 in interest payments, plus £973 for 16 months (£15,568). Your extra cost is £12,000 so you save yourself £7,886.
Before you make the leap, here are five questions you must ask yourself.
1. Do you have other, more expensive debts?
Interest rates on mortgages are low in comparison with many other forms of debt. Data from Moneyfacts show the average mortgage rate is about 2%. Credit-card rates are typically in the high teens.
It’s usually advisable to pay off more expensive debts first. The higher the interest rate, the more the debt will cost you over time. This is because you pay interest on the original amount borrowed as well as on the interest accrued.
According to Moneysaving Expert, if you borrow £1,000 at 15% over 20 years, without making any repayments, you’ll end up owing £16,400.
So, you may want to consider dealing with any unsecured loans or high-interest plastic-based debts, before you think about early mortgage repayment.
2. Will you have to pay early-repayment charges?
If you’re still in a fixed-rate deal, discount, or tracker period, most lenders let you overpay about 10% of your mortgage balance each year without paying fees.
Beyond that, you could face fees, typically between 1% and 5% of the amount overpaid. Alternatively, some lenders present a flat 5% fee, irrespective of how many years you have left on your deal.
If you’ve got £100,000 left on your mortgage and you want to repay the full amount, you might have to pay a penalty of around £4,500.
Most lenders don’t apply an early-repayment charge after the starting deal ends. It might be worth waiting so you can repay your mortgage early without being penalised.
3. Do you have an emergency fund?
Paying off your mortgage might seem like a good way of boosting your future finances, but it’s important to keep enough money for your present-day needs.
Having a rainy-day fund will ensure you can cover emergencies, such as your roof collapsing, boiler packing in, or car breaking down. Ideally, everyone should have such a fund, and it’s wise to keep enough to cover three to six months’ worth of costs.
If repaying your mortgage early means you have no savings to fall back on, it probably isn’t the right decision.
4. Are you investing for your future?
Depending on your means, you might be better off putting your spare cash in a pension or ISA.
Each time you pay into a pension, the government contributes 20% tax relief. If you’re a higher-rate or additional-rate taxpayer, you can claim an additional 20% or 25%. Money in a pension or Stocks and Shares ISA has the chance to benefit from investment growth.
Logically, if your mortgage interest rate is lower than the rate you’re getting on your investments, you may be better off with additional investment rather than debt repayment.
Remember, the value of your investment can go down as well as up, and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
5. When do you plan to retire?
If you’re planning to retire soon, owning your home outright can provide a lot of peace of mind.
After age 55, you can take 25% of your pension as a tax-free lump sum. You could use this to repay a mortgage early. This is a big step, however, and not to be taken lightly.
Your pension and other investments need to generate enough income in retirement so you can live comfortably without running out of money. Taking a large lump sum from your pension will reduce the amount of income you have in the future.
If you don’t have spare cash to pay off your mortgage, you could consider delaying your retirement until your mortgage term has ended. This would prevent your mortgage eating into your longer-term finances.
It can be tricky deciding whether to repay or not repay. If mortgage early-repayment charges are especially high, the decision becomes simpler. Naturally, nobody wants to pay an unreasonable sum, even for the sake of clearing their home loan.
Think about your situation, check the terms of your mortgage, and assess what effect paying off your mortgage would have. If you’re confused or uncertain, the safest option is to consult a financial planner.
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Your home may be repossessed if you do not keep up repayments on a mortgage or other loans secured on it.