It seems to be many people’s goal in life to retire by having a pension and paying off your mortgage. Then you can kick back and enjoy life with no money troubles, right? Well, maybe not. Should you overpay your mortgage? Paying off your mortgage early might not be your wisest financial strategy. There are the following factors to consider when looking at paying off your mortgage early:
1. Could you get a better return on the money somewhere else?
If the cost of finance is very low then there is an opportunity cost of the cash to consider for leveraging money for investing in property, so utilising any surplus money to pay down your mortgage may or may not be the best pound for pound use.
Ask yourself would you be better off saving £200 or making £500 net cashflow a month from renting a property & enjoying capital growth. If you can borrow money at 2% + and make 15%+ return on capital invested on a vanilla buy to let, then you have some serious options weighted in favour of investing.
On my own home I had a small mortgage & started paying chunks off & Mark suggested that wasn’t a good use of the cash . I said that I wanted to do it for my family in case something happened to me, but he pointed out that we have various life insurance & key policies on me, so there would be no need to do this. Of course, there is no right answer & this all depends on your risk profile & your attitude to investing, your interest rate on your home loan & having an unencumbered property at the end of the mortgage term, or before.
2. What are the current and possible future interest rates?
With some great low rate fixed mortgages from Platform and Godiva there are many upsides of re-investing saved capital into BTL’s. All property investors understand the COST of not re-investing.They understand they can make their cash work ‘harder’ by leveraging and re-investing along the way instead of paying off the loan as they go.
It makes far more sense to invest that money and compound the returns, and let it go up and up and up. If you’re existing residential mortgage is coming up for renewal there are some great lifetime trackers deals of just under 2%. You can compound the saving and use the existing lumpy savings into investment properties.
3. Will the current mortgage allow you to pay down the loan early?
It’s always wise to pay off other debts such as credit cards as the interest rates is generally higher. But assuming you don’t have any or have paid these off, do you have an agreement to pay off the loan early and by how much? If you’re paying off a huge chunk & you’re on a fixed rate deal, there will usually be a limit to how much you can pay, usually 10% of the loan amount. Then you would most likely have to pay an Early Repayment Charge (ERC). After the initial rate period ends, there are normally no restrictions, but its wise to contact the lender or check your mortgage offer for more details.
Another thing to be aware of (depending how long you have your mortgage for) is for the first few years, the repayments will be mostly interest. What this means is the repayments will mainly top heavy, so if you want to repay the mortgage with over payments, you’ll find that the amount you owe won’t have gone down by much.
4. What is your age and stage of life?
If you are young, maybe you would get a better £ for £ investment investing the money into other assets rather than paying down existing ones. If you are older, coming towards the end of interest only terms, you have to plan for this. Selling a property or two to reduce LTV may be a viable option. You want to be aware that as you get older, and have more mortgages paid off, the IHT bill you pass on will get higher and higher.
5. Can inflation help you pay down your mortgage?
Here is something you may not know, but are extremely important. Just 20 years ago you could buy a property for £5000 [compare that to a heavily over-priced bottle of champagne in Mayfair now for £35,000 – things have clearly changed a lot!] This means over 25 years all of the money that you pay towards your repayment mortgage will actually be worth much less than what you paid for it relatively.
Don’t suffer from inflation – the money you have been paying will be worth less than what you paid for it (£250K in 25 years time is not the same as £250K today). Pay down your mortgage if you’re comfortable paying off in today’s money an amount which will be worth a fraction of this in 25 years time…
6. Could you get a life insurance policy instead?
This is a quite straightforward policy designed to pay out a flat sum in the event you die. However, this might not be appropriate if you’re residential mortgage is on an repayment basis. As your debt decreases with each repayment you may find that the amount of life cover can decrease at some stage. This is another arsenal you have in your toolbox to combat ‘overpaying’ & leveraging the payments into another asset that will be you month on month and grow year on year.
7. Might you need emergency funds?
Cashflow is king. No-one around us knows exactly what’s around the corner with a job loss, ill health or an emergency fund, so it’s always wise whichever option you proceed (pay off mortgage or reinvest) with to always have a contingency plan in place. It might be an idea to overpay every 2-3 years a lump sum (if thats your choice & you’re risk averse) & although it will cost a lot more in interest you’ll have a lot more control of your money & how you spend it.