We’re living through exceptional times: historically low interest rates combined with rising inflation can’t last forever.
We could be about to enter a more difficult economic environment. So is it a good time to pay down your mortgage in preparation for trickier times – and higher interest rates – ahead?
Paying off a lump sum will reduce the amount of interest you pay in the long term, and cut the length of time you will be paying it off for. But if you have the spare cash to do so, is it necessarily the best use of your money?
“It’s generally a good idea to pay off your mortgage on your main residence as quickly as you can – especially if it will be your family home for a long time,” says Chris Lloyd, associate director at Enness Private Clients. “It will save you money in the long run and protect you from the risks of borrowing huge sums of money.”
For example, by paying down a £10,000 lump sum on a £250,000 mortgage with 25 years remaining, at an annual interest rate of 3.5 per cent, you would save £13,298 in interest alone, and pay your debt off in full one year and six months earlier.
However it’s rarely as simple as just paying off a lump sum – most mortgages have an overpayment clause, often resulting in a penalty. It’s best to check your individual mortgage and speak to an adviser, but most lenders will let you overpay up to 10 per cent without incurring a charge.
By paying down a £10,000 lump sum on a £250,000 mortgage with 25 years remaining, at an interest rate of 3.5 per cent, you would save £13,298 in interest alone
Whether you pay down or not depends first and foremost on your personal circumstances, says Jeremy Duncombe, director of Legal & General Mortgage Club. “You should always get advice, every circumstance is different. Ask yourself how accessible you need that money to be in the future. Once it’s paid off it’s hard to get back – you might need that £20,000 or £30,000 if your circumstances change. You could remortgage but there are costs involved. Whereas if it’s in cash, or an Isa, or somewhere else, it’ll be far simpler to access it.”
Duncombe says that if you’re looking to reduce your monthly payments, swapping your mortgage could be more beneficial than paying down a lump sum. Research from Legal & General Mortgage Club found that moving from a standard variable rate to a more competitive product could save the average homeowner over £2,000 a year – the equivalent of a 7.2 per cent jump in salary.
With current mortgage rates so low, in terms of opportunity cost, paying down your mortgage isn’t necessarily the best option if your spare cash could be yielding more elsewhere.
At the extreme end of the risk spectrum, for those in a healthy financial position looking to profit from the present environment, Lloyd says that “it does sometimes make sense to use your money elsewhere, or even increase your mortgage.”
“If you borrow money at 2 per cent interest, of course you have to pay it back with interest. But if you can invest in something which yields a return which covers that debt, the debt itself can be used as an asset.”
This article appears in the latest edition of City A.M.'s Money Magazine, released with the paper on Thursday 24 March.