The benefits of paying off your mortgage early

Choosing your mortgage is an important decision and usually requires a lot of financial planning and saving before you are able to do so. First, you need to be granted a mortgage, save or borrow funds to put down your deposit, then you have the ongoing monthly payments to manage.

Now depending on the type of mortgage you chose, your monthly payments may be a small or relatively significant proportion of your monthly take home salary. But once the excitement of owning your own home has subsided, you may be looking to upgrade yourself or your family with another investment. For example a new car or a property extension may on on the cards. In this case, you will be looking to put some of your monthly income towards saving for this. Therefore, at this point, you may begin to consider options for freeing yourself from this loan.
Of course this will only be a feasible option if you are on a significantly higher salary than you were when you first took your mortgage, you have recently received a hefty bonus or maybe you have come into some inheritance money. Whatever the circumstance, if there is a means of paying the full sum, this is an appealing option to many. But is this the smartest use of your money?

Read on to find out why paying your mortgage is appealing to some people.

Own your home ‘free and clear’

There is something to be said for the peace of mind that full ownership of your property provides. Many people say that they feel more confident about their overall financial situation when their mortgage lender no longer has a claim to their home.

Save money on interest

Lenders need to power their business somehow and it does not take a financial mastermind to see that simply swapping money – that is, lending clients money that they will eventually pay back by a sum equal to the amount you initially lent them – does not make the lender any net profit.

Paying off any loan in one go can be cheaper overall. If you pay your mortgage off before the payoff date the total amount you pay your lender will be less than it would be if you waited until the final pay off date. How much you save will depend on your current interest rates.

How do I work out how much money I will save by paying off the mortgage?
Check the monthly interest you are paying on your mortgage. Unless you are on an interest-only mortgage, this is not the same as your monthly mortgage payments. Ask your lender what your monthly interest payment is, or calculate it from the interest rate that you are paying.
If your monthly mortgage payment is greater than the interest you are receiving after tax, you will be better off paying off your mortgage.

If you have an interest only mortgage, overpaying on the interest will have no effect on reducing your mortgage cost or term. If you want to make overpayments,you will need to discuss this with your lender.

Motivation to become debt-free

If you would rather not think about investing any excess income at the moment, getting your mortgage paid off quickly could be your first port of call and help you to focus on saving any extra pennies, rather than living an ‘extra’ lifestyle. You may be better off paying extra on a mortgage than spending money on unnecessary items. You are always freeing yourself of the potential of late mortgage payments and the impact that has on your financial record.

Build equity

Equity is the amount of your home that you actually own. When you borrow money to buy your home (via your mortgage), you can calculate your equity by subtracting your loan balance from the value of your home. If the result is a negative number, you have negative equity because the home is worth less than you owe on it. The best scenario is that your home is worth more than you owe on it. If you owe zero, then unless the highly improbable scenario of an entire collapse of the property market occurs, your home will be worth more than you owe on it.

In addition, if you do not have full ownership of your home, you cannot sell it unless you bring cash to the table. When you own a property this is essentially an asset that – whatever happens to the property market – could be used as a financial back up should you come across hard times. In this sense, a property can be viewed as a physical savings account. Whatever it’s worth, it is sitting there and cannot be spent until you sell it.

Paying off your mortgage is a good option if the loan represents a high percentage of the value of the house.

Reduce your cost of living

As alluded to earlier, reducing your monthly outgoings by removing your mortgage repayments provides you with the flexibility to use the money that would be going towards these elsewhere. You could take a lower-paying job, or begin saving for that new car or home improvement instead.

Save on insurance

You may have taken out mortgage insurance if for example you paid a deposit of less than 20%. Foreclosure is a legal process in which a lender attempts to recover the balance of a loan from a borrower who has stopped making payments to the lender by forcing the sale of the property used as the collateral for the mortgage loan. Mortgage insurance is recommended so that, should you be unable to continue paying off your mortgage and your home is sold for less than your outstanding loan balance; the insurance company pay the bank the difference.

Impact on your ability to move home

If you are moving to a similarly priced, or cheaper, property where you will also not need a mortgage, then it makes it easier and cheaper. This is because you will not have to deal with the mortgage company throughout the process, pay their mortgage fees, or use surveyors or conveyancers approved by them.

If you have a portable mortgage and are purchasing a new property at the same time you’re selling your old one, this may also be an option. Porting your mortgage means taking your existing mortgage—along with its current rate and terms—from one property and transferring it to another. If you have a portable mortgage, and would need the mortgage on a new more expensive home, it might be best to stick with the mortgage and use your savings to increase the deposit you are paying on the new home.

Questions to ask when deciding whether to pay off your mortgage

• What is the interest rate on your mortgage, and how does it compare to the interest you can get on a savings account?
• Are there any penalties for repaying the mortgage early?
• Are you expecting any windfalls, such as selling a business, or inheritance?
• Do you have alternative investments that you want to make such as buying another property, or building up a business?
• How much money do you need to have in savings?
• What future financial commitments are you expecting?
• Are you expecting a decrease in income?

Cons of paying off your mortgage early

Every mortgage borrower looks forward to the day that they’re no longer responsible for monthly mortgage payments. But if you are lucky enough to be in a position to pay it all off, is it always best to pay off your mortgage early?

The main reason to pay off your mortgage early is that, often, it will leave you better off in the long run. Mortgage rates are usually higher than savings rates, so if you have a lump sum in a savings account, you will receive less in interest each month than you would save from paying off that amount of a mortgage loan. And being mortgage-free can make it easier to make cutbacks elsewhere – you might, for example, be able to work part-time. Plus, it is usually cheaper and easier to buy and sell your home without a mortgage. Generally, a smaller mortgage gives you greater financial freedom and security.

Why on Earth, you ask, are we not considering paying it off in full then? Well, there are cases where you could be better off investing this money elsewhere. Read on to find out if paying your mortgage is a smart move financially, or if you would be better off in the long term if you invested in something else instead.

The money is no longer yours to invest as you please

Is paying off your mortgage a good investment? Before paying off your mortgage in full, ask yourself the following question: Will I be better off using the money to buy something else? It is true that you would be better off paying it off than simply keeping the money in a savings account. But you could end up financially better off in the long run if you play your cards right and invest the money in the right places. You could invest the funds that you would use to pay off your mortgage in alternative investments such as repairs or improvements to your current home, buying another property, a new car, or even invest in your children’s future by, for instance, paying school fees.

Contrast this with paying off your mortgage where you cannot then use the money for anything else which could potentially earn financial rewards that paying off your mortgage will not. What’s more, it is usually difficult to get the money back again once you have done so. This will involve the time and financial expense of taking out a new mortgage.

Some pensioner bonds, for example, pay higher than mortgage rates. Or you might be confident that a second property or stocks and shares will grow in value each year more than the interest rate on your mortgage. Whatever you decide, do your research, evaluate the potential gains and risks, seek financial advice and make the smartest move to ensure the best outcome overall.  

Penalties

This might seem odd, but there are situations where you will be effectively charged for paying off your mortgage. If, for example, you are on a special mortgage deal, such as a discounted or fixed rate, there are likely to be penalties for paying the mortgage off early. Normally, the penalties decrease towards the end of a fixed rate or discounted period. And you might be able to pay off a certain amount (such as 10%) every year without incurring penalties. Ask your lender if there are any penalties for paying early, and if so how much they are. If the penalties are small, it might still be worth paying off the mortgage early.

However, even if you have enough money to pay off your whole mortgage, keep some aside as savings. For example, if you have a £100,000 mortgage and £100,000 savings, you may want to just pay off £75,000 of the mortgage and keep £25,000 as a rainy day fund.

You can read our short and concise post on porting your mortgage here.