Borrowing money from a lender is an expensive way to fund a purchase. However, taking out a mortgage to enable the purchase of a home can perhaps be classed as a necessary evil. Certainly, the vast majority of people aren’t lucky enough to be able to buy their home without one. The key then is to ensure that you pay as little in the way of interest as is humanly possible and one way to achieve this is to pay off your mortgage quickly.
Basic mortgage rule: the longer the repayment period, the more expensive the mortgage will be:
Mortgages are a type of secure loan and they work on the premise that your bank will lend you an amount of money (called the capital sum) on the basis that you will pay it off within a certain time-frame (called the term). However, as well as paying back the capital sum, you will also need to pay interest on the remaining capital sum for the duration of the mortgage.
It’s important to note, therefore, that the longer you take to pay off the mortgage, the more money your mortgage will end up costing you. To illustrate what a big difference this can make, let’s look at two examples.
Firstly, let’s look at someone who takes out a mortgage of £100,000 over 25 years, at an interest rate of 5%. The total amount they would repay (assuming a capital and interest repayment set up) would be £175,377 over the 25 years.
Now let’s change that scenario. Imagine that they took out the same £100,000 amount at 5% but this time opted to pay it off over 15 years. The total amount they would pay would drop to £142,342 over the 15 years. That’s a cost saving of £33,035 which might easily be equivalent to one year’s salary or more!
Of course, the caveat to this is that paying off the mortgage over a shorter term requires you to be able to pay a bigger amount in each month and mortgage holders must always make sure that the repayment amount that they have agreed to is comfortably affordable. Nevertheless, what this example illustrates is that it’s worthwhile selecting the shortest mortgage duration that you can comfortably afford.
Ways to pay off a mortgage early:
As well as minimising the initial mortgage duration, you may also be able to further reduce the term by stepping up payments and/or making lump sum payments into your mortgage.
Before doing so, however, it’s important to check whether the terms and conditions of your selected mortgage allow early repayment. Variable rate mortgages (sometimes promoted as Flexible mortgages) usually do, whilst fixed rate mortgages often have conditions attached.
A common scenario on fixed rate mortgages is for the mortgage holder to be allowed to make one lump sum payment per year but for this to be limited to 10% of the mortgage value, or they may allow you to increase your monthly payments but, again, only up to a certain amount.
Where you are restricted to one lump sum payment per year, make sure you make the payment on the 1st possible day so that all future interest payments that year are against the reduced capital amount.
It’s worth pointing out that most reputable lenders will allow you to make your lump sum payment and keep your monthly repayment amount at the same level. However, be wary as some lenders may impose rules that state that your monthly payment amount will automatically be reduced if you make a lump sum payment. This effectively serves to ensure that your mortgage will take longer to pay off, so that the lender will make more money from it. Shopping around when deciding on a mortgage, and asking questions about their early repayment options, can save you a lot of pain further down the line.
Don’t be afraid to switch providers:
Even a small reduction in a mortgage rate can make a big difference over the lifetime of a mortgage. Therefore, it’s not just a case of comparing rates when you take out a mortgage; there can also be great value in checking the rates offered by various lenders over the course of your mortgage.
There are often early repayment fees that apply if you try to switch from a fixed rate mortgage which may deter people from switching provider. However, on variable rate mortgages, it’s usually easier to switch and doing so may be worth the short-term hassle of having to set up the replacement mortgage. Again, by minimising the rate that you are paying, you should afford yourself an opportunity to pay off the mortgage earlier and save yourself a lot of money.