Benefits of Paying off your Mortgage Early
With interest rates on savings being so low, many homeowners in the UK are looking at other means of getting a better return on their hard earned cash. Whilst investing in stocks and funds are an option, returns are often unpredictable, especially in light of Brexit and Covid-19. According to consumer group Which?, 46% of homeowners have made overpayments on their mortgage. Here we outline the key benefits of paying off your mortgage early.
Here we outline the key benefits of paying off your mortgage early.
What is an overpayment?
When you originally took out a mortgage, your lender would have informed you of the monthly repayments you are required to make when paying your mortgage. This will be dependent on the amount you borrow, the interest rate of the product you selected and the term (the period of time in which you agreed to pay the loan back).
Mortgage overpayments are when you pay more towards your mortgage than the amount set by your lender, with the aim to become mortgage free by paying your loan balance faster.
The flexibility offered when paying off your mortgage early by making monthly payments or lump sum payments depends on the mortgage details and your lender (early repayment charges may be applicable too. Read our article here to learn more).
For example, if you borrowed £300,000 on a repayment basis at interest rate of 2.5% over 25 years, your monthly payments that the bank will set would be £1,346 per month. Now if you decided to pay above £1,346 each month then this would be considered a mortgage overpayment.
What is an overpayment?
1. Save Money, tax free
Overpaying gives you the same return tax free, as the rate of interest you are paying on your mortgage. For example, if you are paying 2.5% interest on your mortgage, then overpayments will give you a tax free return of 2.5%. By making overpayments, you are reducing the size of the loan owed to the lender and therefore the interest costs you need to pay.
Using our previous example, if you regularly overpaid £200 a month you could save £18,069 in interest alone.
We recommend you having a look at a repayment calculator online to see the impact of making regular overpayments. With savings rates so low, it is virtually impossible to find deals that will save you more money especially as you pay tax once you have used your personal savings allowance.
For example, if you find a savings account that also pays you 2.5% in interest, then you will likely earn less, as you are required to pay income tax on this. Thus, overpaying can be a tax efficient way to become debt free sooner and pay off your mortgage early.
2. Mortgage free, faster
The amount you overpay goes towards repaying the original amount you borrowed, which results in you taking less time to repay your debt.
If you regularly overpaid £200 a month, your mortgage would be paid off 4 years and 2 months earlier.
For the average homeowner, the largest household expense is their mortgage. Once that debt is paid, you are that much closer to reaching financial independence which itself has its own benefits, such as:
· Reduce stress
Being mortgage free, reduces anxiety and provides you more control over your finances as you are now free from one of the expensive debts you may have.
· Live your life
You have more options as you know you can live on less and you can choose to use the extra cash to build you your savings or spend on the things you want guilt free, as you now own the property outright.
· Retire early
It is estimated by research conducted by L&C Mortgages that approximately 3 million people expect to be paying off their mortgage completely after state retirement age of 65.
3. Access to better mortgage deals
Lenders provide better deals to those who have more equity in their property, known as ‘loan to value' (LTV). This refers to the amount you borrow versus the value of your home. By overpaying your mortgage, you are reducing the amount you owe and hence your LTV.
If you able to overpay and go below one of the lenders thresholds then you are more likely to get better mortgage deals and save even more money when you remortgage. Typical lender thresholds for most mortgages are – 90%, 85%, 80%, 75%, 70%, 65% and 60%.
Example, if you borrowed £300,000 and your property is worth £450,000, then your LTV is 66.6%. If you paid off an additional £7,500 your LTV would now be 65% and you would be able to unlock cheaper deals.
4. Save more if overpay now, rather than later
Many people in the UK tend to make a large overpayment as a lump sum payment once they have built a large amount of savings and are approaching close to retirement age. Banks are aware of this and so by front loading the interest payments, they are able to earn their profits from you sooner and in turn, you end up paying more. This is known as amortization, see this YouTube video from #homeceo to learn more.
At the beginning of your term, your monthly payments is paying the bank mostly interest, rather than paying back the original loan. So the more you overpay earlier on during the term, the more money you save in interest. Whereas if you are overpaying later in the term, you are paying more principle and saving much less interest.
5. Increasing payment flexibility
Overpaying your mortgage puts you ahead of your payment schedule which could provide the flexibility of underpaying further down the line should you need to.
However it is important you check the lender's policy before choosing a deal if this is something you would like to do, as not all banks allow this.
If the benefits outlined above are making you think that this is something you want to start doing or be doing more of, then we suggest you register for 'early access' to the Sprive app.