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How to pay off your mortgage early

Written by Dana Dratch

It’s fair to say that many of us dream of paying off our mortgages early. The average mortgage term is 25 years. Provided you’re on a repayment mortgage and have never lengthened the term, you should be mortgage-free, 25 years after you first got the home loan.

Even if you’ve secured low interest rates each time you’ve remortgaged, you’ll still have paid tens, or even hundreds of thousands of pounds in interest alone. 

Paying off that mortgage early would mean your debt racks up far less interest, as well as leaving more cash in your bank account, each month.

So, how can you become mortgage-free? 

Here are four steps you can take to pay off your mortgage early, minimise the amount you spend on interest and free up your income.

  1. Shorten your mortgage term

  2. Overpay your mortgage

  3. Remortgage

  4. Pay fees upfront

Shorten your mortgage term

Shortening your mortgage term means promising your lender you will pay back what you owe in a shorter period of time.

Here’s how it works:

You take out a £200,000 mortgage with a 3-year fixed rate of 2.5% over a 25-year term. At the end of three years, you’ll have 22 years left on the mortgage, have repaid some interest, and still owe £188,187.

At this point, you could simply get the cheapest 22-year mortgage you can find. Or, you could get a mortgage with a 20-year term instead.

By shaving two years off the term, your monthly payments would increase from £928 to £997. However, you would save £5,522 in interest over the term of the mortgage (assuming you switch to a new mortgage deal with an interest rate of 2.5% every two years).

As you can see, for an extra £69 a month, you could save thousands of pounds in interest and be mortgage-free, two years sooner. 

Indeed, if you were able to shave two years off your term every time you remortgaged, you could be mortgage-free in as little as 14 years. You could also choose to reduce the term by one year, or not at all when remortgaging, depending on your financial situation at the time.

Shortening your mortgage term is clearly a great way to clear that debt sooner. But because your payments will be spread over a shorter period of time, your monthly repayments will increase. Make sure you are in a financial position to meet these higher costs.

Calculate your monthly mortgage repayments

Overpay your mortgage

Overpaying your mortgage is when you pay more than the required amount, each month, and can help you pay off your mortgage much sooner. You only benefit if your lender allows overpayments on your particular mortgage. If not, you may have to pay a charge.

For example, you take out a £200,000 mortgage with an initial interest rate of 2.5%. Assuming your interest rate stays at 2.5% (i.e. you keep switching to a new promotional deal every few years) your monthly repayments will be £897 and you’ll be debt free after 25 years.

If you can overpay by £100 per month you’ll increase your monthly payments to £997. However, this will mean you will save £9,953 in interest alone and shave an impressive 3 years and 4 months off the term of your loan. What’s more, if you could overpay by £200 per month, you could save £17,367 in interest and pay off your mortgage nearly 6 years earlier.

Most mortgages allow for overpayments of up to 10% per year without penalty – but it is vital to check your paperwork or ask your lender to be sure. The last thing you want is to cancel out the financial gains of overpaying by landing yourself with a fee. 

You should also tell your lender that you would like the overpayments to reduce your debt (shorten the term) rather than change your monthly payments, or you won’t clear the mortgage any faster.

Overpaying is a more flexible method to hack away at your mortgage debt than shortening the term as you can always stop the overpayments, should your finances change. 

Remortgage

Unless you remortgage to cheaper deals throughout your mortgage term, you’ll eventually end up on your lender’s standard variable rate (SVR).

The typical SVR is currently around 3.57% whereas the average 2-year fixed rate mortgage is 1.42%. This means when your two-year fixed rate deal finishes, you’ll be charged more interest.

For example, say your mortgage is £200,000 and fixed at 1.42% for three years on a 25-year term. After three years, you revert to your lender’s 3.57% SVR – and remember, variable rate mortgages can go up or down.

Without remortgaging at all (and assuming the rate remains at 3.57%) you will have paid a total of £293,436 by the end of the mortgage.

If you had remortgaged to another 1.42% fixed-rate mortgage and did this throughout your remaining 22-year term, the overall payment would be £237,733. This means you’ll have saved nearly £56,000 in interest, just by switching mortgage deals every few years.

Although remortgaging can save you huge amounts of money, it can come at a cost in terms of fees, time and paperwork, so be sure to carefully weigh up the pros and cons first.

Get an offset mortgage

When you come to remortgage, you might benefit from an offset mortgage. An offset mortgage provides a link between your savings account and your mortgage with the same lender.

Your cash savings are offset against the size of the outstanding home loan, so you’ll pay less in interest.

For example, you have a £200,000 mortgage and £10,000 in savings. Here, your £10,000 ‘linked’ savings reduce your mortgage by the same amount, meaning your debt goes down to £190,000 (£200,000 minus £10,000).

As monthly payments are usually worked out on the whole debt (£200,000), you’ll pay less interest and overpay your mortgage without penalty, meaning you could pay it off sooner.

Offset mortgages are generally best for higher tax rate payers or those with large sums in savings.

Pay fees upfront

Mortgages with temptingly low interest rates advertised can often come with high fees, which can be as high as £2,000. It’s common to tack these fees on to the mortgage amount to avoid having to pay them upfront.

In doing this, you potentially reduce your chances of paying off your mortgage early, because your monthly repayments will increase.

However, if you can pay the fees in a lump sum at the start of your mortgage, you’ll pay less interest overall and are more likely to be in a position to overpay (within the limits set by your lender) and pay off your mortgage early.

Should I pay off my mortgage early?

Paying off your mortgage early is usually a savvy decision. It can save you thousands of pounds in interest payments over the mortgage term.

But there are a few situations where it might make sense to do something else with your extra cash. Here are three questions to ask before paying off your mortgage:

1. Should you put your cash into a savings account instead?

Put very simply, if a savings account has a higher interest rate than your mortgage, it might be better to save your money rather than pay off your mortgage loan.

2. Does your mortgage have an early repayment charge (ERC)?

Most mortgages with an introductory period, including fixed, tracker and discount mortgages, have an early repayment charge (ERC). This is usually a percentage of the remaining mortgage loan. 

For example, say you've got a £200,000 mortgage that's fixed for 2 years. If it has an ERC of 2%, you would have to pay the bank £4,000 if you pay off your mortgage early.

Longer fixed rate periods, such as a 5-year fixed mortgage, often have a larger ERC. The early repayment charge also applies if you remortgage to a different lender.

As most mortgages do not have an ERC after the introductory period ends, it can be worth allowing your lender to move you onto its Standard Variable Rate (SVR), so that you can pay off the remaining debt, penalty-free.

To find out if you have an ERC on your mortgage, check your mortgage documents or phone up the lender and ask.

3. Should you clear other debts first?

Mortgage debt is likely to be the cheapest debt you have, which makes it a no-brainer to concentrate your efforts in paying off other, more expensive borrowings first, like credit card or loan debt.

It makes very little sense to overpay on your mortgage if you're paying 20% interest on your credit card balance!

COVID-19 Coronavirus – update for mortgage borrowers

On 2 June 2020, the Financial Conduct Authority (FCA) confirmed that homeowners whose finances have been affected by COVID-19 can apply for a three-month extension to their mortgage payment holiday. Homeowners unable to make their mortgage payments who have yet to apply for a payment holiday have until 31 October 2020 to do so.

Mortgage payment holidays ease the burden of having to make monthly payments at times when you may be struggling to make ends meet. However, it is important to remember that this is not free money – it is simply extending the term of your mortgage by 3 months. Your home loan will continue to build up interest during this time, meaning the total amount you will pay back over the term of your mortgage will be higher.