Why It's Vital To Overpay Your Mortgage Now
Why overpaying your mortgage now could lead to a better deal next time you remortgage.
With the Bank of England base rate down to a tiny 2%, many of you on tracker and standard variable rate mortgages will now be enjoying lower monthly repayments.
If you're smart -- and you can afford to -- you may already be following my Foolish friend, Rachel Robson's advice. In her recent article: Make The Most Of The Base Rate Cut, Rachel tells us why it makes sense to continue to make the same monthly mortgage repayments, even if your interest rate has been cut. This means you can overpay your mortgage without actually spending any extra money every month.
Overpayments allow you to do two things: One, clear your mortgage early. And two, save heaps of interest to boot. In fact, you would be a fool not to!
On the other hand, fellow Fool writer, Cliff D'Arcy reckons if your mortgage repayments have been reduced following the recent base rate cuts, it could be even better to save the surplus in a high-interest savings account. As he explains in Save More Or Pay Off Your Mortgage, this could work out well if you can earn more interest on your savings (after tax) than you're paying on your mortgage.
Why overpay?
Both ideas have their own merits, but overall I'm more convinced overpaying is the best solution right now. Here's why:
We all know the dreaded credit crunch has played utter havoc with the mortgage market. A couple of years ago, a 10% deposit or equity stake in your home would have been more than sufficient to secure a decent mortgage deal.
But these days the most competitive home loans are reserved for borrowers with a whopping 40% to put down. That's one reason why it's so important to get your loan-to-value (LTV) -- which is your mortgage loan as a percentage of the value of your home -- as low as possible. And the quickest way to do that is to pay your mortgage down as quickly as you can by overpaying.
Take a look at the table below which shows how much mortgage interest rates differ depending on the borrower's LTV:
Two-year fixed rate remortgage deals from the UK's biggest mortgage lenders
Lender | Lowest Fixed Rate With 10%+ Equity (90% LTV) | Lowest Fixed Rate With 25%+ Equity (75% LTV) | Lowest Fixed Rate With 40%+ Equity (60% LTV) |
|---|---|---|---|
Abbey | 5.84% * | 4.49% | 4.29% |
Barclays (Woolwich) | No deal available | 4.99% ** | 4.39% |
Halifax | 6.44% * | 4.79% | 4.69% |
HSBC | 6.99% | 5.79% | 5.19% |
Lloyds TSB/C&G | 5.69% | 4.59% | 4.29% |
Nationwide | 6.68% * | 5.78% | 5.38% |
Northern Rock | 6.69% * | 5.19% | 4.79%*** |
RBS NatWest | 6.64% | 4.99% | 4.99% |
Average | 6.42% | 5.09% | 4.75% |
LTV = Loan to value. *Based on a maximum LTV of 85%. ** Based on a maximum LTV of 70%. *** Based on a maximum LTV of 65%.
The table compares the lowest rates on offer to remortgagers with equity stakes of 10%, 25% or 40%.
Borrowers with a 60% LTV -- in other words, those who have a 40% equity stake -- could pay an average rate of 4.75%. This is 0.34% lower than the deals available at 75% LTV, and a whopping 1.67% lower than the average rate on offer to borrowers with just 90% LTV.
Having a 60% LTV is a fantastic position for any borrower to be in. But a 61% LTV normally puts borrowers up into the next category, making interest rates more costly, even though the difference in equity is just 1%.
Falling house prices
When you next come to remortgage, you'll put yourself in the best possible position for a competitive mortgage deal if you manage to get your LTV down. But the trouble is, as house prices continue to fall, reaching that all-important low LTV is becoming increasingly difficult.
According to research by Savills Estate Agents for The Sunday Times, even people who bought homes ten years ago could see the level of equity in their properties slump dramatically by 2010. These homeowners currently have 51% equity, but Savills reckons this could drop to just 25% (or a 75% LTV).
If Savills are right, when these borrowers next come to remortgage, the best deals -- like those shown in the table -- will no longer be in reach.
Indeed, brokers at The Fool's Mortgage Service say the average LTV for borrowers who have remortgaged in the last three months is 51%. Right now these homeowners should be able to access the best mortgage deals, but it could be a very different story if house prices do indeed fall significantly by 2010.
So that's why I think it's really important to overpay your mortgage if you can. This will help you to combat collapsing house prices and reach a lower LTV.
Even if you haven't just had the benefit of an interest rate cut, it still makes sense for all homeowners to overpay. After all -- credit crunch or not -- the sooner you become mortgage-free, the better!
More: Rate Cuts Winners And Losers| Mortgage Curbs Continue, But Don't Despair | Compare mortgages at The Motley Fool Mortgage Service
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Comments
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Well done Jane - very good article, apologies for not posting sooner, I've been toiling over this and other articles by Rachel Robson & Cliff D'Arcy an after reading other fool boards I felt confident enough to follow the Foolish way and overpay my mortgage... I have a tracker mortgage (2.7%) with 4yrs 3mths or 51 payments to go. My current monthly payment is £234pm. Being as I am outside of any penalty clauses I am able to pay a small lump sum and overpayment per month. I should add I am non tax payer, Ex HM Forces and my personal circustances deem this a prudent move for me. I pool'd all my different savings together an paid £2760 as a overpayment and a overpayment £100p/m as a way of paying off my mortgage possibly by 2011 if not sooner (apologies if figures don't add up countings not my best fortie). I hope by 2011/12 there will be more boyancy in the market, whereby I can bolster my savings as a way to compliment my small pension in future years. (Blondebimbette): You can set up a seprate DD for the increased amount or do monthly transfers. All you need is the account No, sort code & Mortgage Roll Number as Reference. Hope that helps.
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Quick q: How does one overpay??? My mortgage company take their money by monthly DD, and I'm sure they only accept capitla repyaments in large chunks, which I don't have...do i send them extra cheques every month??
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About 3 years ago, inspired by a TV series on how to pay your mortgage off in 2 years, we set about to do just that. OK, we started from a quite low £52k, but on the 15th November 2008, we were only just a bit late in achieving the goal. I read the comments from some clearly clever fools, and my head starts to spin trying to figure if my idea was sound! So I have to thank RCHUMBA for his comment [i]"The over riding point is to get rid of your debt, mortgage is debt, debt is debt, get rid of it as fast as you can, then worry about what to do with your money afterwards."[i] It slowed my head spin down. Sure I realise that perhaps I could have made a few more quid doing it another way, but the 'feel good factor' we now have (especially coming up to Christmas) makes it worth it. I recommend it to all. Seasonal greetings to everyone.
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14 January 2009