Donna Werbner explains how you can cut the costs of your mortgage -- and even get rid of it altogether!
Wouldn't it be great if you could be mortgage-free within a decade? Imagine owning your home outright. How wonderful would it be not to have the noose of those monthly mortgage payments around your neck?
Sounds amazing, doesn't it? And the icing on the cake is, if you pay off your mortgage more quickly than you first intended, you'll actually save yourself thousands and thousands of pounds in interest.
Example:
Amount borrowed at 5.5% | Mortgage Term | Amount paid in interest |
|---|---|---|
£150,000 | 25 years | £126,339 |
Amount borrowed at 5.5% | Mortgage Term | Amount paid in interest |
|---|---|---|
£150,000 | 10 years | £45,347 |
Total amount saved by reducing mortgage term from 25 to 10 years: £86,513
The trouble is, by spreading your payments over 10 years instead of 25 years, you will push up the size of your monthly payments (in this case, from £944 to £1,647 a month - an increase of 57%).
Few of us could afford to increase our mortgage payments by 57%. But don't be put off - there is another way to cut the costs of your mortgage and become mortgage-free.
Conflict of interest
Say for example you had a £150,000 mortgage debt and £5,000 of savings sitting in a bank account. Typically, if you've got a competitive mortgage deal, you'd be paying around 5.5% interest on your debt. And if you've got the most competitive savings account, you'd be earning around 6.3% interest on your savings.
So far, so good - you seem to be receiving a higher rate of interest on your savings than you are paying out on your mortgage debt.
But remember, with a savings account, you're earning that 6.3% before tax. This means that if you are a higher-rate taxpayer, you would actually receive just 3.78%, while a basic rate taxpayer would receive 5.04% net.
Conclusion: your debt is growing at a faster rate than your savings.
How can you stop this from happening? One way would be to take your savings and make an overpayment on your mortgage. Many mortgage lenders nowadays allow you to do this (although if you are overpaying by more than £500, some will only allow you to do it once a year). This would immediately reduce your mortgage debt and cut the amount of interest you would have to pay.
But this would leave you without any savings which, for most homeowners with bills, boilers and roofs to worry about, is not a great option.
Luckily, there is an alternative.
Take out an offset mortgage
An offset mortgage works by balancing your debt against your savings. The more savings you have, the less interest you will have to pay on your debt.
Confused? Here's a quick explanation of how it works:
You agree to link up your savings account (and current account if you want) with your mortgage by placing all three with the same bank or building society. And the bank or building society agrees that, instead of paying you interest on your £5,000 of savings, it will stop charging you interest on £5,000 of your mortgage debt.
As long as you keep that £5,000 in your savings account, you will only pay interest on £145,000 of your mortgage debt, instead of the full £150,000.
Not only are you effectively earning interest, after tax, at the interest rate of your mortgage, but you are also reducing your mortgage term.
How? You are reducing the amount of interest you have to pay, but keeping your monthly payments at the same level. So a greater proportion of your payments every month will go towards repaying the capital debt you have borrowed.
Here's a worked out example, using Intelligent Finance's Home Purchase Offset Tracker 75:
Amount borrowed | Amount kept in savings account | Amount saved every month | Amount saved in interest | Amount saved in years |
|---|---|---|---|---|
£150,000 | £5,000 | £100 | £53,715 | 4 |
By keeping £5,000 in your savings account and saving a further £50 every month, you would reduce your mortgage by £53,715 and be mortgage-free in just 21 years.
If you have more savings, and can save a greater amount, the figures are even more dramatic:
Amount borrowed | Amount kept in savings account | Amount saved every month | Amount saved in interest | Amount saved in years |
|---|---|---|---|---|
£150,000 | £25,000 | £500 | £127,447 | 9 years, 4 months |
Not only would you have paid off your mortgage in just over 15 years, you'd have built up £175,000 worth of savings as well. And remember, during those 15 years, your savings would always be accessible should you need to access your money in an emergency (although the moment you took the money out of your savings account, your mortgage debt would effectively increase).
It is also worth bearing in mind that you will usually pay a slightly higher rate to get an offset mortgage. So if you don't have any savings to offset and don't plan to save in the future, it probably won't suit you.
For those of you lucky enough to have a healthy savings balance, however, it is almost a no-brainer - so what are you doing hanging about and allowing your mortgage debt to grow?
> Visit our award-winning Mortgage Service and find out more about offset mortgages today!