With real incomes squeezed, and house prices high, would-be buyers are being given a stark choice: stay where you are, or sign up for a longer mortgage term.
According to the Council of Mortgage Lenders, around a fifth of new loans to house purchasers are for terms of 30 years or over — 35-year terms are common, and lenders Halifax and Nationwide offer 40-year terms.
Why such long terms? Because it’s the only way to get a monthly repayment amount that is affordable.
Consider a £200,000 loan at 4%. Using an online mortgage calculator, you can quickly discover that over a traditional 25-year mortgage term, the monthly repayments would be £1,056 per month.
But over 35 years, the same loan requires monthly repayments of just £886. Extend the term to 40 years, and the monthly repayment drops even further, to £836.
The longer the term, the more you repay
The downside of all this affordability, though, is the increased cost to the buyer. Simply put, the longer the term over which you borrow, the more you pay.
The total repayments on that 25 year loan, for instance, amount to £316,702. Extended to 35 years, those more affordable repayments see the borrower pay back £371,931 — over £55,000 more.
And 40 years? Borrowers of a nervous disposition should look away now: £401,221, a whopping £85,000 more!
Which is an awful lot of money.
What to do?
The obvious answer, of course, is to make mortgage overpayments. Your scheduled monthly payments might be £886, in other words, but instead you pay £986, a hundred pounds more.
The result? The mortgage is paid off earlier, and the overall amount you repay is correspondingly reduced.
In the case of the figures above, for instance, a 35-year mortgage would be paid off almost seven years earlier, with the overall amount repaid falling from £371,931 to £333,968 — a saving of £38,000.
Not so easy
There are two problems with this, though.
The first is that if paying an extra £100 a month was affordable and easily doable, then people would do it and avoid the longer-term mortgage in the first place.
But the fact is that it isn’t always doable. Some months you can, some you can’t. Overpayment at Christmas, and in January, when the credit card bill is due? No. Overpayment in September and October? Not an issue.
Which takes us to the second problem with making overpayments: mortgage lenders don’t like them. Most will let you make some sort of overpayment, but restrictions typically apply, with some lenders even applying penalties to compensate them for the fact that they won’t be making as much money out of you as they originally thought.
Derisory returns
But instead of making periodic mortgage overpayment, here’s another way to reduce the length of your mortgage — and, what’s more, do so without incurring penalties.
Instead of making occasional mortgage repayments, simply save the money you put aside in an investment account instead — and then make one massive repayment, at the end.
But don’t save in a bog-standard savings account. There’s no point earning a derisory 1.5% in a savings account if instead you could use the money to reduce a loan that’s charging 4%.
Harness the stock market
Instead, put the money in a stock market investment fund — ideally a nice, cheap index tracker.
That way, with the market delivering long-term returns of 7% or so, compared to 1.5% in a savings account, your returns should soon outpace the gains from making additional repayments on a 4% loan.
Put another way, overpaying a 4% mortgage by £100 a month for 20 years would knock £36,799 from the amount owed.
But invested in the stock market at 7%, the same £100 a month would build up to £52,396 — almost £16,000 more, allowing the mortgage to be paid off even more quickly!
