The monthly mortgage payment makes up a large chunk of many homeowners’ monthly outgoings. Here are ways on how to pay off your mortgage early.
Understand the mortgage payment profile
Data from the UK Land Registry (Jan’19) states that the average UK property value is currently £228,147. Of course, if we were to include London that average would increase significantly. Let’s approximate the average to £230,000 for this example.
Say you bought a property for £230,000 using a 10% deposit (£23,000) and a mortgage of £207,000. The mortgage is for a term of 25 years and 4% fixed rate repayment (capital and interest repaid monthly) for 3 years. Here is what your capital and interest payment profile looks like over the 25 years:
You’ll notice that the interest payments are higher at the start of the mortgage before declining, while the capital payments are lower at the start and increase over the term. This makes sense as the more you pay off the capital balance, the interest on a lower outstanding capital reduces month-on-month. This is known as an ‘amortizing’ payment profile.
The above also shows that in your first few years of mortgage payments, the payments consist of a higher proportion of interest compared to capital, which brings me to my first point in paying off your UK mortgage;
Pay capital earlier
If you are able to, use lump sums to pay off the capital early in the mortgage term. This way you are reducing the outstanding capital balance and subsequently the interest portions that make up your monthly payments. Use any bonus you receive or accumulated savings to pay down that capital. Short term pain, but long term gains.
This is especially true in high interest rate environments. You don’t want to be paying those high interest rates at the start when none/little of the outstanding capital has been paid off.
Extra payments periodically
Based on my example above, the monthly payments due for a 25 year fixed rate (4%) mortgage on £207,000 is £1,092 per month. Now consider these scenarios;
SCENARIO 1 – If you pay an extra £200 monthly, you will reduce your mortgage term by 6 years, i.e 19 years in total.
SCENARIO 2 – If you pay an extra £400 monthly, you will reduce your mortgage term by 10 years, i.e 15 years in total.
SCENARIO 3 – If you pay an extra £200 monthly AND pay £10,000 annually against your outstanding capital, you will reduce your mortgage term by 15 years, i.e 10 years in total!
SCENARIO 4 – If you pay an extra £400 monthly AND pay £10,000 annually against your outstanding capital, you will reduce your mortgage term by 16 years, i.e 9 years in total!
The below graph illustrates the Scenario #4 (£400 monthly and £10k annual overpayment);
Of course, it is not entirely feasible to overpay monthly – especially with large lump sums. Other expenses and priorities get in the way. But hopefully the above scenarios shine light on the benefit of making extra payments on your mortgage.
Invest surplus cash for compounding returns
Take advantage of an income generating investments like a DRIP (dividend reinvestment program) that can produce 7% return – which I believe is conservative anyway. Your surplus cash should be put to work, and by investing it in income investments, say an mixed equity and bond income fund – you can use the power of compounding and use the returns towards paying off your mortgage.
So instead of using money from your savings (which generate negligable return anyway), invest that money. Converting the figures from Scenario #4 above on a monthly basis gives £1233.33 (£10k/12 + £400).
If we invest £1233 per month at a 7% return, this generates a balance of £214,658 by year 10. See below profile of mortgage capital o/s vs investment balance;
As you can see, the investment balance will be sufficient to pay off the mortgage balance at around year 8 – 9. Again, bearing in mind that the individual has to pay £1092 for the mortgage, and £1233 towards the investment – giving a total monthly cash outlay of £2325.
Be careful. Refinancing/remortgaging is useful to take advantage of low interest rates, but what you are doing by refinancing is resetting the clock. This is because when you refinance with a new lender or even the existing lender, you will enter into a brand new mortgage term, starting from time t = 0, and as discussed earlier – your first few mortgage payments will be weighted towards higher interest payments. My advice;
If rates are low – enter into a variable rate mortgage as it will be tracking low interest rates. If rates are high – then best to shop around for a competitive refinance deal.
Reduce your mortgage term
Opting for a shorter mortgage term means you’re mortgage is paid off quicker, but the monthly repayments will be higher. The advantage however, is that with a shorter term, say 10 or 15 years, the average interest rate applied to the mortgage will be lower than that of 25 year term. The Lender will usually follow a standard yield curve which presents lower rates in the short term, and higher rates in the long term.
Reducing your term will entail a formal agreement between you and your lender. This makes it best suited to homeowners who can definitely afford to pay more every month.
Pay your mortgage fees upfront
There are usually mortgage fees that the lender will charge relating to administration and any other reasons they can think of! In the UK, these fees are typically £995 or £1995. We have the option of paying the fees now or adding them to the mortgage.
It is preferable to not pay those mortgage fees (usually £995 or £1995) initially. But by adding it to the mortgage balance, it becomes part of the loan and is subject to the same interest rates over the life of the loan. For example, by adding the £995 fee to the loan, you end up paying an extra £581 in interest (over the life of 25yr mortgage @ fixed 4%, for example). Similar, adding the £1995 fee to the loan means you pay an extra £1164 in interest (or £3160 in total!)
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