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Retirement. For many, it's a vision of relaxation, travel, and finally pursuing passions. But for a growing number, this dream is clouded by a persistent worry: the mortgage. If you're approaching retirement with years of payments still looming, you're not alone.
Rising interest rates and longer mortgage terms mean more people are facing this challenge. The dilemma is: should you prioritise paying off your mortgage before you stop working? Or is your money better saved for a rainy day, or spent elsewhere?
If you can afford to, paying your mortgage off early could save you thousands in interest and take the pressure off your retirement income. However, there’s a lot to consider first.
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Paying off your mortgage early not only frees you from monthly repayments but also reduces the total interest you’ll pay on your mortgage over time. Let’s take the example of a £150,000 mortgage with 15 years remaining and a 4.5% interest rate.
If you paid it off five years early you would save yourself £29,710 in interest – and you’d be mortgage-free for those last five years. Overpaying can sometimes mean you save money when you remortgage. This depends on how much you have left on your mortgage.
If your overpayments mean you drop beyond one of the loan to value thresholds – usually 90%, 85%, 80%, 75% and 60% – you’ll often get a better rate. But if your mortgage is already less than 60% loan to value, it probably won’t make a difference.
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, says: “If you have a mortgage stretching into retirement, then it may give you peace of mind to know that this ongoing payment has been dealt with. If it’s something that worries, you then do the maths to see if it is affordable and won’t leave you struggling.”
The financial benefits of overpaying depend on how much interest you’re paying on your mortgage versus what your money could earn elsewhere. Generally if your mortgage rate is around the same, or higher than your savings rate, then you’ll save by overpaying.
If your savings rate is higher, it still might not be clear-cut, depending on whether you pay tax on your savings. Using an online mortgage overpayment calculator can help you determine whether making a mortgage overpayment is the best financial move for you. You can also use a compound interest calculator if you want to see how much you might earn on savings over a longer period, assuming the interest is added to your savings.
If you’re better off with savings, you could save the money now to earn interest, then use it to pay off a chunk of your mortgage at a later date, when your mortgage might start costing more than you can get on your savings. It can also depend on whether you’d definitely save the money otherwise. For example, if you decide not to make monthly overpayments when perhaps you could afford to, would you just end up spending that money on non-essentials?
Before you overpay your mortgage, it’s also worth considering if you’re better off investing your spare cash instead. For example, you could be putting that money into your pension instead. If your mortgage interest rate is lower than the return you could earn from investments, it may make more sense to invest in a pension or stocks and shares ISA instead.
However, being mortgage-free means guaranteed savings, while investments carry risk and you may not get back what you put in, so it’s not a straightforward decision and it depends on your attitude to risk. Some people consider using their tax-free lump sum from their pension to clear their mortgage.
“There’s lots of things you need to consider before taking money from your pension to clear your mortgage,” says Helen Morrissey, head of retirement analysis at Hargreaves Lansdown. “You are potentially taking a huge chunk of the money you need in retirement to pay this off and you need to be aware that you may leave yourself short of money later on in life.”
If you are still working, it might be better to overpay gradually from your income rather than withdrawing from your pension. Downsizing could also be an alternative if you’re willing to move.
If you’ve decided it’s the right choice for you, there are several ways you can overpay your mortgage to pay it off early. The most obvious is by increasing your monthly repayments.
David Hollingworth, associate director at L&C Mortgages, says: “Making an additional payment each month can be a great way to gradually chip away at your mortgage. Even a relatively small monthly overpayment can make a big impact on the total interest bill and even help to repay the debt early.”
For example, on a £150,000 mortgage at 4.5% with 15 years remaining, overpaying by just £100 a month (so increasing your monthly payment from £1147 to £1247) would save you £6,747 in interest and allow you to pay off your mortgage 18 months early.
Some people make overpayments by switching to smaller fortnightly payments instead of their standard monthly payment. The idea is that by making half your regular mortgage payment every two weeks, you end up making 26 payments, the equivalent of 13 monthly payments, so an extra full month’s payment each year. However, this method isn’t necessarily ideal.
“This needs to be checked with your lender as to how best to do it in practice. Most lenders will typically take payment by direct debit each month and the borrower need to be sure that they won’t fall foul of appearing to be behind,” says Hollingworth. This is because in making two payments a month, lenders might think you’re paying half your money late.
And if you have monthly income coming in, fortnightly payments could slip out of sync with that, which could potentially give you cashflow problems. So making regular monthly overpayments is generally a simpler and more effective way to pay off a mortgage early.
If you have savings available, making a one-off lump sum payment can significantly reduce the interest you pay over time. “A lump sum makes a bigger initial dent in the balance and so will also cut the total interest,” says Hollingworth.
For example, if you made a one-off £10,000 overpayment on the same £150,000 mortgage and continued with your original £1,147.49 monthly repayments, you would save £8,979 in interest and knock 18 months off your mortgage.
The best of both worlds, if you’re in a position to change your mortgage deal, could be an offset mortgage: reducing your mortgage interest and keeping your savings accessible. “For those with significant savings but a reluctance to commit everything to mortgage overpayments, an offset mortgage can be a great tool,” says Sarah Tucker, founder of The Mortgage Mum.
“It reduces the amount of interest you pay, without requiring you to part with your savings, providing both flexibility and long-term financial benefits.” With an offset mortgage your savings are held in a linked account and, while they don’t earn interest, they reduce the amount of mortgage interest charged, helping to clear the mortgage faster while keeping your savings accessible.
Make sure you understand your mortgage and the terms attached before making any decisions about overpayment.
What’s your current mortgage deal and how might it change in future? For example, if you are on a fixed-rate deal, when does it end, and is your next deal likely to be better or worse (based on how interest rates have changed since then)? If you got a good deal on a five-year fix four years ago, you’re likely to be on a low interest rate now (meaning you could get a better return in a savings account compared to what you’ll save in mortgage interest), but it might be more worthwhile to overpay once you’re paying more interest on your next deal.
It’s important to check your mortgage terms to see if you can overpay without penalties, and by how much. Usually penalties only apply above a certain level. “Lots of lenders will let you make overpayments of up to 10% of your loan amount if you’re on a fixed-rate deal,” says Tucker, “and if you’re on a tracker rate you may be able to overpay by more. Check your mortgage offer to make sure.”
Or if you can’t find the paperwork, contact your lender to check. It’s also worth knowing how much the penalties are and how they compare to the interest you’ll save.
Can you avoid penalties by spreading the overpayments slightly differently, without paying much more interest? Sometimes you can overpay as much as you like in the last month of your current mortgage deal without incurring penalties – does this apply to you?
Usually when you make an overpayment your lender will ask if you want the following payments to be reduced (so that you finish paying your mortgage at the originally scheduled date) or if you want to maintain your existing monthly payments.
If you do the former, your overpayment won’t have achieved that much, as you’ll only save a tiny amount of interest and you won’t pay your mortgage off any sooner. So make sure your following payments don’t go down. It can be worth giving your lender a call to make sure that the arrangement is the one you want.
Before making any overpayments on your mortgage, it’s important to assess whether it’s the best use of your money. If you have more expensive debts, such as credit cards or loans, it makes sense to pay those off first.
Don’t forget to consider whether you have any other significant expenses coming up, and to weigh your mortgage overpayments against any competing financial priorities. Make sure you have enough cash for a rainy day, as once you’ve overpaid into your mortgage, you can’t get the money back.
It’s generally recommended to have three to six months of living expenses readily accessible. You may also be better off paying more into your pension to secure tax relief on your contributions and increase your income in retirement.
A financial adviser can help you assess whether overpaying your mortgage or saving for retirement is the best strategy. By carefully considering your options, you can make a financially sound decision that aligns with your overall retirement goals.
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