FOOL'S EYE VIEW
Paying Your Mortgage Off Early

By Stuart Watson (TMFTiger)
September 3, 2002

Whether to pay off your mortgage early or not can be a tricky decision to make. Assuming you do have some cash spare at the end of each month, or you get a one-off lump sum, it's definitely something you should look at. Here are six things to consider before taking the early repayment plunge.

1. Do you have other debts?

Let's start with the obvious. There is little point paying off a mortgage costing you 5% if you have other loans costing more than this. Some credit cards and personal loans can cost up to 30%. So pay any of these off first, starting with the worst. With personal loans you'll need to check you don't get penalised for making an early repayment. Even if you don't have any such debt at the moment, if you think you may do in the near future then you may be better off hoarding the extra cash for the time being.

2. Are you allowed to?

Not all mortgages allow you to pay over the agreed monthly sum, while some may allow you to make repayments up to a maximum of 10% of the capital each year. This may be sufficient if you just have a little bit left over each month. But if you have a larger sum, perhaps from an inheritance, it may not be enough. Of course you could hang onto the cash and pay off 10% for a number of years. Alternatively, why not consider switching to a mortgage that gives you more flexibility when it comes to repayments.

3. When should you do it?

You might think sooner rather than later is the correct answer. The way your mortgage interest is calculated is important though. Newer mortgage products often charge interest daily. So if you make a repayment today the interest you get charged starts reducing from tomorrow. In this instance sooner is likely to be best.

Some mortgages charge interest on an annual basis. This means the interest for the next twelve months is calculated with respect the balance outstanding on one particular day. If you make a repayment it could be up to twelve months before you reap the benefit in terms of lower interest charges. If you have one of these mortgages you either want to make a one-off repayment just before the day in question or, better yet, switch mortgages to one that charges interest daily!

4. Can you get your money back if you need to?

If your circumstances change and you want to get your repayments back will you be able to? Again, this will depend on the type of mortgage you have. If you've overpaid in the past you may be able to negotiate with your lender to ease off on your payments for a while later on. If you have a flexible or current account mortgage you'll probably have freedom to do so anyway. As you may have already gathered from the first few points, if you're intending to be a serial re-payer these products are well worth looking into.

5. The risk vs reward trade off

Now comes the tricky bit! How do you decide between the certain and untaxed return that paying off your mortgage gives you and the uncertain and possibly taxed return of investing your spare cash instead.

You'd expect a better return in the long run from investing than you'd get from paying off debt. If this wasn't the case everyone would want to lend money and no one would invest. Given the volatility of stock market returns, the longer your mortgage has left to run the more attractive the investing option is likely to be. If you have less than 5 years to go then, if we follow the well-worn adage that you should not invest money for a shorter period than this, the mortgage repayment option should be the number one choice.

Of course there are times when the sums move more in favour of early repayment. Only a couple of years ago mortgage rates were over 7% and inflation was not much different from its current level of 2%. Paying off the mortgage then, considering what has happened to stock market since, would have proved to be a good decision. Note that mortgage rates have come down to around 5% since so you won't have saved quite as much interest as initially thought.

Your attitude to risk and the prospects for your income are also important. The more risk averse you are the more attractive paying off the mortgage is likely to be. If your income is volatile, or even under threat, then reducing your level of monthly outgoings whilst you can is likely to be attractive too. (For more on the various arguments have a look at this article from our archives.)

6. How much to repay?

It's important to think ahead when making these sorts of sums. Many of us just focus on what will happen over the next twelve months when it comes to making financial decisions. But the long-term calculations are far more significant. You want to pay a meaningful amount but you don't want to overstretch yourself. You also want to make sure you're still paying a worthwhile amount into your retirement plan too.

Say you have a £100,000 mortgage at 5%. Here's how the various repayment options stack up. You can see that paying off an additional £200 a month you actually save over £30,000 in interest over the term of your mortgage.

Mortgage       Monthly       Total
  term         payment        paid

25 years          £585    £175,500
20 years          £660    £158,400
15 years          £791    £142,380
10 years        £1,060    £127,200

You can find out more about flexible mortgages and do the sums for your own mortgage using the calculator in our mortgage centre.