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“Why your house beats the bank”
Investing is all about trading off risk and return. To get high returns, you usually have to risk losing money. Playing it safe means accepting lower returns. With interest rates at rock bottom, life has become a lot tougher for conservative investors in recent years. Hold your money in a savings account and you’ll be lucky even to match the real rate of inflation, let alone get a “real” (after inflation) return.
What if there is a way to get a higher return on your savings, with little risk and NO tax to pay? Well, if you have a mortgage there is.
You might think that with borrowing being so cheap, it’s not really worth paying your loan off. However, if you have low equity and a bigger mortgage (90%-95% loan to value) you will typically pay rates of 4% of more.
When it makes sense
If you struggle to meet monthly payments or need cash for other items, then overpaying your mortgage will not be for you. However, if you have spare money then it is something to consider. By paying more than your usual mortgage payment each month, you reduce the size of the outstanding loan. This means you pay less interest next month and you can pay off your mortgage faster and live mortgage free earlier than you thought you could.
The savings on interest payments you make are equivalent to saving tax-free. If your mortgage rate is 4%, any overpayments give you a clear return of 4%. To get that return after tax on a savings account, a basic rate taxpayer (20% tax) would need to earn 5% before tax and a higher rate taxpayer(40% tax) 6.7%.
The great thing about overpaying your mortgage (as with any debt repayment) is that the savings compound for as long as you have the mortgage.
There is a risk that a drop in house prices will reduce the value of your equity (house value less your outstanding mortgage). However, you would still be better off than you would have been, if you hadn’t made the overpayments. If the value of your house remains stable, overpaying will increase the level of equity in your home. This is especially true in the early years of a mortgage, when most of the monthly payments comprise of a much higher level of interest as opposed to capital.
Building up equity may even allow you to get a cheaper mortgage a few years down the line. It will also reduce the risks of suffering negative equity (when your mortgage is greater than the value of your house) if the housing market crashes. It is also safe to assume that interest rates won’t stay low forever. As interest rates rise, your tax-free savings will be even bigger.
Things to Consider
Firstly, before you decide to overpay, make sure you won’t incur any penalties from your provider. Secondly, consider liquidity. Overpaying your mortgage may pay more than a savings account, but getting hold of your money if you need to might be a problem. If you are worried about having money tied up in your house, consider an offset mortgage (where the amount of money in the savings pot reduces the value of your outstanding loan).
Example
You buy a house for £300,000, have a £30,000 deposit and a £270,000 mortgage (90% LTV) at an interest rate of 4%.
Overpayment | Amount paid back | Time to pay back | Interest Paid |
None | £427,548 | 25 years | £157,548 |
£300 per month | £381,999 | 18 years 5 months | £111,999 |
The above example gives a monthly payment (capital and repayment mortgage) of £1,425 per month. Lets say you can afford to pay £300 more per month (£1,725) and maintain that every month. If rates stayed the same throughout the term of the loan, you could pay off your mortgage over six and a half years early and save over £45,000 in interest, compared with having a mortgage of 25 years.
For more help and advice please do not hesitate to contact Clare at Hoskin Mortgages.
‘THIS BLOG PROVIDES INFORMATION, IT IS NOT ADVICE. ANY OPINIONS ARE GIVEN IN GOOD FAITH AND MAY BE SUBJECT TO CHANGE WITHOUT NOTICE. OPINIONS AND INFORMATION INCLUDED WITHIN THIS EMAIL DO NOT CONSTITUTE ADVICE. (IF YOU REQUIRE PERSONAL ADVICE BASED ON YOUR CIRCUMSTANCES, PLEASE CONTACT US)’
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