What is a mortgage?
It is, of course, a type of debt. And since debt is often considered a “negative word”, it can be tempting to think, therefore, that you should seek to pay off your mortgage early. But is this always a good idea? Wouldn’t surplus money be put to better use on other things such as increasing your pension pension contributions or taking out a life insurance policy?
Some people argue that interest rates are, historically-speaking, very low these days and so there is less incentive to own your property outright as soon as possible. On the other hand, interest rates are unlikely to stay as they are, forever. They could conceivably rise.
As with most financial matters, there isn’t a straightforward answer to this question. Whether or not you should pay off your mortgage early inevitably varies from person to person, depending on factors such as your current financial situation and future goals.
However, there are some useful principles and considerations to take into account when weighing up the precise time frame and manner in which to pay off your mortgage. Let’s examine some of those in turn:
#1 Do you have the money?
It sounds like a simple point, but it’s an important one. If you have paid off £200,000 on your home and have £80,000 left to pay off, do you actually have the money in hand to pay off the outstanding amount (and cover any other relevant fees/taxes which may be involved)?
Assuming you do have the money, it’s crucial that you consider how spending this money on paying off your property will affect your overall financial health. If spending £80,000 effectively leaves you with no other savings, then you need to consider how you and your family would cope in a situation where you need a financial reserve, but do not have one.
Sometimes expensive surprises come our way, such as replacing a broken boiler or booking an emergency flight, and it pays to be ready with an emergency fund. As a guiding principle, try to aim to build a minimum savings pot containing three months’ worth of living costs to help cover you in these sorts of scenarios.
#2 Check your mortgage terms
Some mortgage lenders will not let you pay off your mortgage early, and virtually all lenders impose conditions on early repayment. Commonly, banks will let their customers overpay up to 10% of the mortgage value per year without incurring any charges. However, it’s important to check and talk to your lender to be absolutely sure. There is little point trying to repay your mortgage early only to face a substantial financial penalty.
#3 What would happen if you died?
It’s not nice to think about, but you need to consider what would happen to your home in this scenario - especially if you have children or other dependents.
Life assurance policies provide a terminal benefit when their provisions are met, which can help your family settle outstanding debt on your mortgage. You need to check the terms of these policies carefully, however, as they will not always pay out in all scenarios. If you die by participating in an extreme sporting event or due to substance abuse, then your family may not receive the payment from the insurance company.
The general point is this. Would you have less reason or motivation to pay off your mortgage early if you took out a life assurance policy?
#4 Other debts
The interest you pay on a mortgage over time is certainly significant. However, you also need to be careful not to focus on your mortgage debt to the exclusion of other ones.
£1000 of unpaid credit card debt, for instance, could lead to about £200 in interest over the course of 12 months r if the annual percentage rate (APR) is over 18%. Does it really make sense to ignore this debt and focus only on overpaying your mortgage?
Not only do you need to consider the hard numbers, you also need to factor in the detrimental effect unpaid credit card debt has on your credit rating.
#5 Pensions & investments
It might sound strange to talk about pensions when the subject here is about paying off your mortgage early. However, you do need to consider whether you would be better-off putting more money into your pension pot, versus putting it towards overpaying your mortgage.
Remember, the UK government will effectively boost your contributions to your pension pot in the form of tax relief. Basic Rate taxpayers get 20% tax relief on their contributions, and Higher Rate taxpayers get 40% (subject to contribution limits). Effectively, that means that it “costs” Basic Rate taxpayers £80 to put £100 towards their pension. For those in the Higher Rate it would “cost” £60.
Here’s the point. It might make more financial sense for you to increase your pension contributions rather than pay off your mortgage early. Or, it could be that in your particular case, the best solution lies somewhere in between - e.g. increasing your pension contributions slightly, whilst putting a lump sum (or higher overpayments) towards your mortgage.
Speaking with an experienced financial planner will enable you to discern the different options in this respect, helping you identify the best way forward in line with your financial goals.
The aim of this article is not to put you off repaying your mortgage early. After all, paying even a £10,000 lump sum towards a £300,000 mortgage would lead to a significant saving in the long term, in the form of reduced interest.
However, it is important to consider the question of early repayment within the wider context of your overall financial plan. It’s rarely a good idea to repay your mortgage only to leave yourself with other significant debts or without any reserve funds, for instance.
You should also take a look at insurance policies which might have a bearing on your decisions in this area, as well as the situation with your pension(s). Bringing all of this together can be a challenge on your own, so this is where working with a reputable financial planner can bring you a lot of value and peace of mind.
Punter Southall Aspire offer a comprehensive range of mortgage products from across the market. We can offer advice on the entire range of products available to suit your own particular circumstances and are not restricted to any one particular lender. We offer a no obligation, initial consultation of up to 30 minutes – at no cost to you – for all mortgage business enquiries. Contact us today.
This article is featured in the summer edition of In Focus, our quarterly newsletter packed with articles to keep you informed on the important issues in financial planning.Click to read In Focus - June 2019
Topics: Insights & Advice