Personal Finance - Shedding the mortgage load

Many of us have entertained the idea of paying off our mortgages early at some stage in our lives. But the problem, until recently at least, was that most mortgages have tended to involve a regular monthly repayment for a fixed term, usually of 25 years.

Mortgage interest relief at source (MIRAS) was one factor making 25-year mortgages more acceptable. By offering tax relief on the first £30,000 of a loan – especially when house prices were much lower and MIRAS applied at a borrower’s highest tax rate – repayments were effectively subsidised by the Revenue.

Not any longer: as of April 2000, even today’s scant MIRAS benefits, which are now worth barely £20 a month, will disappear. But for many people, the habit of gradually paying off a 25-year loan remains as strong as ever. Can such habits ever be broken?

The good news is that shortening the life of a home loan is far easier – and less painful – than we think. Setting aside the cost of a (modestly priced) bottle of wine each week can lop months, even years, off a mortgage term, cutting many thousands of pounds in interest payments.

Figures from the Halifax tell the whole story. Paying off a £100,000 mortgage at today’s standard variable rate of 6.95% would cost £694.50 a month over 25 years. Paying an extra £20 a month reduces the loan period to 23 years and five months, a saving of £7,575 in interest payments. An extra £50 a month would cut the mortgage term to 21 years and five months, saving £17,758.

How easy is it to pay off the money early? A Halifax spokesman says: ‘It’s no problem. There are two ways to do it. One is by making a part-repayment, which means paying in a reasonably large lump sum as a one-off measure. For us the minimum is £500. If you make a part-repayment, we will then recalculate the amount you would have to pay each month, based on the lower capital sum you owe.’

The spokesman adds: ‘The other way is to overpay. Every month you pay an extra amount over and above what would be needed for that mortgage’s original term. All borrowers need to do is to go into their normal branch and discuss the matter with staff. The mortgage account is then set up to accept the extra payments, thereby reducing the mortgage term.’

It is also possible to part-repay with a lump sum and then, instead of opting for reduced payments, continue making them at the higher rate.

Your lender will recalculate the mortgage term, based on the higher payments that are now being made.

There may be cases, however, where early repayment is not possible. Where a borrower has taken out a special fixed or discounted mortgage, for example, there are redemption penalties for part repayments in the early years.

Here, it is always possible to set the money aside in a high-interest ISA account and pay off the loan once the penalty period is over.

There is a further problem with many lenders. For the most part, they calculate the total interest owed on a loan only once a year. This means that any unintentional overpayments, or any payments where you have not notified the lender of your intentions, are not deducted from the capital owed until that lender’s annual review date.

That is why an increasing number of mortgage lenders are offering the option of daily interest calculations on the amount you owe. Every penny of capital paid reduces the interest owed – from close of business that day. Yorkshire Bank, one lender which calculates interest daily, calculates that using its daily ‘rests’ (as they are known in the trade) would lop nine months off a traditional 25-year £100,000 mortgage, assuming a 6.95% variable interest rate.

Combining daily interest-rate calculations with extra payments of just £2 a week gives even greater benefits. First Active, a company that offer mortgages by telephone, calculates that on a loan of £75,000, with interest rates of 6.99%, a weekly overpayment of £2 would lop one year and five months off a 25-year mortgage term. Making the same payment daily (£2 a day), rather than once a week, would save five years and nine months and £23,101.

Increasing payments by 2.95% every year – roughly matching the present rate of inflation – on a £100,000 loan with Yorkshire Bank would save £39,166 in interest charges, while cutting eight years and nine months from the length of a loan.

More flexible options, now available from a number of lenders, include being able to overpay a mortgage, take payment holidays and even borrow back some of the money already repaid.

Two lenders with highly competitive ‘flexible’ mortgages are Standard Life and Legal & General, both of which offer a variable rate of 6.05%, with, respectively, a 1.5% and 1.55% discount in the first six months of the loan.

A handful of lenders, including First Active, Virgin Direct’s One Account and Kleinwort Benson, go even further. They offer ‘bank account mortgages’, where you pay in your monthly salary, which is immediately credited against the outstanding loan.

As the month wears on, you can use the mortgage account like any other bank, signing cheques and using local cashpoints. Any spare cash goes towards paying off the loan – but you can also use the overpayment if you need it.

Tony Ward, managing director at First Active, says: ‘We believe in putting our customers in control of their personal finances by giving them this facility. This is the kind of flexibility people need.

‘Flexible mortgages were once seen as a niche product. But they are now becoming more mainstream – and any company offering them is bound to do well.’

And in the process, borrowers look set to do well too. First Active’s variable rate varies between 6.99% and 7.74%, depending on the amount borrowed. Virgin’s is 6.6% to 7.2%, while Kleinwort’s is 6.45% – but with a minimum income requirement of £100,000.

CASE STUDY: PAYING THE MORTGAGE LOAN OFF EARLY

Ian Radley and his wife Vanessa, both aged 35, opted for a flexible mortgage which gives them the option of making overpayments on their debts each month, thereby paying off the loan early.

‘Our loan is for £75,000 and the payments would be about £550 a month,’ says Ian, a civil servant living in Letchworth. ‘But in practice we pay in an extra £100 a month. What it means is that our 25-year loan should be fully repaid in 14 years, which is handy because I will be entitled to retire in 12 years or so’s time.’

CASE STUDY: MORTGAGE AS A SAVINGS ACCOUNT

John Dablin, aged 52, is not too far away from retirement as a software engineer. Penny, his wife, is a part-time personal assistant and faces the possibility of a variable income stream. Yet the couple have an 18-year mortgage, extending well into John’s retirement.

The solution? They have opted for a flexible mortgage. While the notional target date to pay off the loan on their Aylesbury home remains the same, in practice they aim to have it repaid well before then.

‘We currently pay about £550 a month,’ says Penny, ‘which is about £150 more than we need for the 18 years we agreed at the outset.’

The couple agreed a monthly repayment figure with their lender. They also transferred about £10,000 from another high-interest account into the mortgage one

‘That means we are effectively earning a higher rate of interest – the prevailing rate payable on the mortgage – on our money. What is more, it’s tax free, unlike an ordinary bank account,’ Penny adds.

Nick Cicutti is the personal finance editor of the Independent

FREE MORTGAGE GUIDE

Accountancy Age is offering its readers copies of a free ‘Guide to Flexible Mortgages’, written by Nic Cicutti. The guide, sponsored by First Active, explains everything you need to know when choosing a home loan, including tips on what to watch out for, questions to ask prospective lenders and how to pay off your mortgage.

Call 0800 550551 for your copy, mentioning Accountancy Age.