Having a big mortgage hanging over your head can feel like a huge burden. You may be allergic to having such high levels of debt and want to be able to clear it down and be rid of it as soon as possible. In this blog post, we will help you start thinking about the important factors to consider when deciding whether to increase your mortgage repayments or not.
Everyone has completely different needs and financial situations. That’s why they call it ‘personal’ finance. This discussion is not a definitive guide on what you should or shouldn’t do but can help see in what situations it may be favourable for you.
Before you make any concrete decisions, it would be wise to talk to your financial advisor and your bank. They will help you evaluate the implications of upping your mortgage repayments. It can be a useful task to run the new numbers taking into account your proposed additional repayments, to see what the overall financial benefits could potentially be.
1. Could the money be better utilised elsewhere?
Before you go and put any extra cash against your mortgage, assess your current financial situation to see if there are any other potential uses that could be of greater benefit.
Do you have an adequate-sized emergency fund to deal with one-off events? It’s important to have a buffer there to help you when life comes at you rather than having to run to the bank to draw down a costly personal loan or overdraft.
Do you have any other credit that needs to be repaid? If you have a balance on your credit card or any overdraft the interest rates on these will be way higher circa 15-23% compared to your mortgage which will be 2-4%. It will be far more beneficial to you to pay off the debt that has attracted the highest APRs.
Have you maxed out your pension contributions? You can get tax relief of up to 40% on pension contributions you make. That means for every €60 you contribute, you get the benefit of €100 added to your pension fund which can grow tax-free until your retirement.
Are there any other deposit accounts or investments that will pay you a return that is greater than the amount of interest you will save by paying down the mortgage quicker? Depending on what your risk tolerance is there may be a net benefit to investing the additional cash instead of allocating it to your mortgage. A mortgage is likely to be the cheapest form of loan you will ever receive in your lifetime.
2. Fixed or Variable Rate Mortgage
There may be limits to how much you can overpay on your mortgage without facing additional fees depending on whether your mortgage rate is fixed or variable.
If you are on a variable rate mortgage then there should be no limits to you paying off as much of the mortgage as you please whenever you want.
For fixed-rate mortgages the story is different, there will be fees if you break certain limits which differ depending on the mortgage provider that you are with. Let’s check out conditions as currently laid out by some popular mortgage providers in Ireland.
Avant Money – You can overpay by up to 10% of your balance per year (in up to 2 separate installments) without incurring a fee.
Bank of Ireland – For fixed rates the maximum monthly overpayment is 10% of the monthly mortgage repayment, or €65, whichever is greater.
AIB: Less favourable terms for AIB fixed-rate mortgage holders. If a Fixed Rate mortgage loan is fully or partially repaid early or you change to a different interest rate during the fixed-rate term, an early breakage cost may be applicable.
3. Lump sum payment vs increase in regular payment
Before deciding to either make a lump sum or to increase your monthly repayment, it is worth comparing the effect of this on the term of the mortgage ( if your goal is to pay off the mortgage ASAP).
For this, we will look at a simple example. The Kirwan family has €110,000 and 15 years left on their mortgage which has a variable rate of 3.15%.
|LUMP SUM||INTEREST SAVING||TERM REDUCTION|
|€5,000||€2,917.49||Under 1 year|
|€10,000||€5,626.58||1 Year and 8mths|
|€15,000||€8,137.86||2 Years and 6 months|
|€20,000||€10,461.31||3 Years and 3 months|
|INC IN REGULAR PAYMENT||INTEREST SAVINGS||TERM REDUCTION|
|€50||€2,293.93||1 Year and 1 month|
|€75||€3,304.32||1 Year and 7 months|
|€100||€4,237.64||2 Years 1 month|
|€150||€5,906.26||2 Years and 11 months|
|€200||€7,354.70||3 Years and 8 months|
What we notice from the tables above is that a lump sum will generally save you more on interest in the long run. You can achieve equivalent reductions in the terms and interest savings on your mortgage by simply increasing your monthly repayment.
There are numerous calculators online that will help you tailor this to your own situation that are definitely worth checking out.
4. How mortgage overpayment should be used
If you decide that you want to go ahead and start making mortgage overpayments and choose the option of making a lump sum, then you will have a further consideration to make.
Do you want the lump sum to reduce the overall term of the mortgage so you are debt-free sooner, or you could also use the lump sum to decrease future monthly repayments and keep the term the same as it is now?
There is no such dilemma if you choose to increase your monthly repayments, this will inevitably lead to you shortening the term of your mortgage.
Before you do anything make sure to check with your bank to see if making the additional payment leads to you incurring additional fees. If there are fees then it may not be worth doing.
Again, it is vital that you have all of your other finances dealt with so you know you are in a comfortable position to be able to make such payments. Booking some time with a financial planner may only be a small cost but it could help achieve your financial goals and make you do it as efficiently as possible.
Disclaimer: This blog post is for information and educational purposes only and should not be construed as financial advice.