Every homeowner who has a mortgage looks forward to the day when the whole loan will finally be paid off, releasing them from their obligation to pay the lender each month and freeing up extra disposable cash.
But if you do come into a lump sum, is it a good idea to pay off the whole or part of your mortgage early?
Why Pay Your Mortgage off Early?
The main reason to pay off your mortgage is that you will often be left better off in the long term.
In fact, it’s usually a good idea to get rid of any debts that you have in order to save you paying out on interest charges unnecessarily, especially in the current climate where most mortgage rates are much higher than savings rates.
This means that if you were to place your lump sum into a savings account, the interest you would receive would be less than you would save from settling your mortgage.
In addition, if your home is mortgage-free, it can be easier to reduce your working hours if you want to, or could allow you to retire a little earlier.
You won’t need to worry about defaulting on the mortgage payments and potentially putting your home at risk if your circumstances change.
In short, a smaller mortgage or none at all gives you more security and freedom.
If you decide to downsize and move to a smaller property, you won’t need another mortgage and you would be in a position to buy outright.
This makes moving cheaper and easier as you won’t have to deal with a mortgage lender, pay their fees or use conveyancers or surveyors approved by them.
However, if you have a portable mortgage, it might be better to stick with the one you have and use all or part of your lump sum for a large deposit on the new property.
Reasons not to Pay Off Your Mortgage
If you were to put your lump sum into a savings account of some kind, the money is yours to do with as you like.
However, once you’ve paid off your mortgage, you can’t then use the money for anything else, unless you decide to sell your property to release the equity and downsize.
Depending on the terms of the mortgage you have, you may be liable for hefty penalties if you decide to settle early.
Generally, penalties for early settlement reduce the closer you get to the final mortgage payment, but you should ask your lender for details of how much you would have to pay.
How to Work out How Much You Could Save by Early Settlement
The first thing to do is to look at how much monthly interest you are paying on your mortgage.
Ask your lender what the interest payment is, and then find out what interest rate you would get on your lump sum as savings.
Remember that the first £1,000 of interest is tax-free if you are in the lower tax band, but the rate is 45% on all interest received if you’re in the top tax bracket.
If your monthly mortgage payment is more than the interest you will receive on your savings after tax, you may be better paying off your mortgage.
Before making your final decision, always discuss your options with an experienced financial adviser – as each case would be different in many ways,