The Higher Your Mortgage, the More You Can Save
Opt for a flexible mortgage and the potential to save money in the long term can be truly breath taking.
When you sign up for a mortgage, there is always that moment when you look at the total you will actually be paying over the course of the term and think to yourself that you are in the wrong business. How much, you might ask yourself in disbelief.
The current trend towards mortgage terms of 25 or even 30 years has made it possible for more people to get onto the property ladder and buy the homes of their dreams. But it also means that in the long term, those 800,000 pound mortgages are actually costing a further 50 percent, or even more.
The more you pay, the less it costs
It’s an interesting equation, but the truth is that the more you can pay out, and the sooner you can do so, the less your mortgage will actually be costing you. Making overpayments, either by way of one-off lump sums or adjusting up the monthly repayment can make a lot of sense.
The way a traditional repayment mortgage works is that your monthly payments initially go towards paying off the interest, and then towards the loan amount itself. This means that in those early years, you get the somewhat dispiriting experience of seeing the outstanding loan amount barely dented by all those monthly payments.
Any overpayment you make goes directly towards the mortgage itself, not the interest. This means that you will pay off the total amount sooner, but that the interest due will also come down, as this is calculated on the outstanding balance that is owed.
A typical example
Suppose you have taken out an £800,000 mortgage over 25 years at a rate of 3.5 percent. Your monthly repayments will amount to £4,006, and assuming the rate remains constant throughout the term, 25 years later you will have paid off your mortgage, at a total cost of £1,201,909.
Now suppose you were able to pay an additional £650 per month. The effect will be twofold. First, you will pay the mortgage off in 20 years, not 25. Secondly, the total cost of doing so will be £1,112,196.
Is there a downside?
Saving almost £100,000 and becoming mortgage-free five years earlier sounds like a win/win. But we all know there is no such thing as a free lunch. There is no “catch” as such, but there are two points to keep in mind.
The first concerns any restrictions in the mortgage. Some lenders do not allow overpayments, or levy significant fees that negate the benefit. So keep this in mind when choosing your mortgage product in the first place, and make sure you discuss the possibility of overpayments with the lender before you sign up.
The second is affordability. If you have that spare money each month, then fine. But if finding it means you either incur or are less able to pay off other debts, then again, you might do more harm than good.
If in doubt, a meeting with an independent financial adviser to decide on the optimum strategy is always a worthwhile investment.