How to pay off a mortgage early
For homeowners, paying off your mortgage sooner rather than later is the dream. But when it comes to property and money, there will always be pros and cons, so your best bet is to consult with an expert before you make any big decisions.
It's a good idea to know as much as you can about the process to protect yourself and your finances. Today, our expert team of financial advisors will provide some essential advice you need to know about how to pay off a mortgage early.
Should I pay off my mortgage early?
Although paying off a mortgage early sounds like something that every homeowner should aspire to, it really does depend on circumstances. For example, if you have plenty of money and can afford to pay off your mortgage while supporting the many other crucial aspects of your life, you are likely someone who can afford to pay off their mortgage early. However, this isn't the case for everyone.
Below you'll find a list of pros and cons for paying off a mortgage early. It's always essential to apply these pros and cons to your own financial situation and establish if it's actually a viable solution.
· You remove a significant financial burden from your life
· Your mortgage no longer impacts the potential for other investments
· You can invest in endeavours that may pose more risk but more reward
· Free up more disposable cash for your family
· Build equity in your home to leverage better loans
· You lose liquidity (the ease of being able to access and spend the money you have). I.e. if you choose not to pay off your mortgage and keep the money in a savings account, it can be accessed at any time.
· You lose tax deductions on mortgage interest payments.
· When you pay off a mortgage, it's removed from your credit mix, which could slightly knock your credit score.
· Less money is available to put into investments.
Do you save money by paying off a mortgage early?
Firstly, you need to find out your mortgage's monthly interest. This won’t be the amount you pay monthly (unless you have an interest-only mortgage) as that figure includes your capital payment plus interest.
The easiest way to find this out is to ask your lender or calculate it from the interest rate you pay.
Then think about how much you would set aside in savings and how much interest you would earn on that. Then, work out how much tax you’d pay on the interest gains. The initial £1000 of interest is tax-free for lower rate taxpayers, and top-rate taxpayers pay 45% tax on all interest received.
Now the simple part – if monthly mortgage payments are higher than the interest you receive on your savings after-tax, your best bet is to pay off your mortgage. If the opposite happens to be true, then you may find that paying off your mortgage early is less beneficial in the long run.
As you can see, there isn't one correct answer to this question, and it does depend on circumstances and the specifics of your mortgage. Once you have the information you need, you can make a more informed decision.
Are there penalties for paying off a mortgage early?
Every business operates to make a profit, and mortgage lenders are no different. They make a profit on the interest from loans, so by paying off a mortgage early, they receive less in the way of interest. This is why many mortgage lenders include an early repayment charge (ERC) in your deal, which is incurred if you overpay (pay more than they allow) or pay off your mortgage. Again, this isn't always the case, so it's essential to consult with your lender if you want to pay off your mortgage but are concerned with penalties.
An ERC is usually between 1-5% of your outstanding mortgage, which doesn't sound like a lot, but when you consider that 1% of a £100,000 loan is £1000 — it's not something to be taken lightly. It's also worth noting that early repayment charges can reduce as you have the deal for a longer period.
Your mortgage contract will outline all of these charges, so dig out your paperwork to read the details.
Can I pay a lump sum off my mortgage?
You can indeed! In fact, it's a very common occurrence for homeowners who come into a large amount of money (e.g. a good investment or inheritance) and want to take a chunk out of their mortgage repayment. By doing so, you not only reduce the amount you owe and simultaneously reduce the amount of interest you pay — but of course, you reduce the time it will take to pay off your mortgage altogether.
It should be noted that you should always consider the most beneficial use for large sums of money. If you feel as though you can pay a lump sum off your mortgage without seeing an impact on your other finances or commitments, then why not?
How does extra payment shorten a mortgage?
This is a very common question about mortgage repayments. People tend to want as much information as possible before they commit to early payment — and rightfully so. The amount of time and money taken off your mortgage depends on the overall cost, interest rate, mortgage duration, recurring overpayments and type of mortgage. If this is information you don't have on hand, you can request this from your lender.
Fortunately, The Money Saving Expert has a helpful tool for calculating mortgage repayment savings. So, as an example:
You have a mortgage debt of £200,000 with a 25-year term, 3.5% interest rate, £200 recurring overpayments and a £5,000 lump sum payment. With these factors entered into the calculator, you could save around £30,000 and take 6.5 years off your mortgage.
When it comes to working out the savings on your mortgage, it's vital to consult a financial advisor. Fortunately, we can help if you get in touch today!
How can I pay off my mortgage faster?
There is a wide range of ways to pay off your mortgage faster, many of which we mentioned already in this article. Here are a few extra ways you can pay off your mortgage faster.
1. Reduce your mortgage repayment term: The first and most obvious way to repay your mortgage early, aside from a full repayment, is to shorten your payment duration. Doing so means that you have to pay a higher repayment each month, but you will benefit from lower interest.
2. Implement recurring repayments: Besides paying your monthly mortgage repayment, you can also set up additional repayments. Some people opt to do this monthly. Others do so every two weeks. This is an efficient way to repay your mortgage early if you lack the funds for a more significant lump sum. But check with your mortgage lender to find out the max you can overpay each year without incurring charges.
3. Make an extra mortgage repayment every quarter: If you can be savvy with your savings it's possible to make an extra mortgage repayment every quarter. This will essentially become an annual lump sum payment that consistently reduces your mortgage amount, interest, and repayment duration. If you feel as though this is something you can afford to do, it can prove to be hugely beneficial.
4. Repay a lump sum: As we’ve mentioned, a lump sum is a great way to take a hefty chunk out of your debt while benefitting from lower interest and a shorter repayment period. However, it's always important to consider your overall financial situation and consult a financial advisor before investing a lump sum. If you are comfortably paying off your mortgage and a large amount of money could be better spent elsewhere, it's crucial to consider your options.
5. Downsize: While this may not be the ideal or most appealing option to some, for others, it provides the means to get out from under the burden of mortgage debt — which can be very appealing indeed. Whether you simply do not need a larger property or your living circumstances have changed, downsizing offers a range of financial benefits.
Want to know more about paying off your mortgage early?
Check out our internal mortgage advice service for all the advice and guidance you need!