Becoming mortgage-free efficiently

jamesd

This is a topic to discuss efficient ways to become mortgage-free in the context of lifetime financial planning and to support people who are doing it.

As Martin wrote in his introductory post "Paying off your mortgage is the best risk-free way to use your cash". If unwilling to take any risk describes you, this topic isn't the one for you. Most of the efficient ways to clear a mortgage involve investments, or at least investment tax wrappers, and investments inherently have some risk.

Off topic, except to point out how wasteful it is, is discussion of making regular overpayments. If you want to discuss that one, particularly in a favourable way, please use one of the thousands of other discussions in this section. If you want to discuss why this topic exists please do that in About Becoming mortgage-free efficiently.

On topic is discussion of becoming mortgage free in the context of an integrated financial plan including pensions, ISAs, investing, retirement planning, living decently if you can't work again, exploiting the tax system to clear a mortgage efficiently and many things other than throwing money away on regular overpayments. If you don't think that regular overpayments can be throwing money away, that's also a good sign that this topic isn't one for you.

jamesd

An initial rough draft of this one.

Why lifetime financial planning and why does it matter for mortgage clearing?

Easy enough: I plan to clear my mortgage without any net spending any of my own money. If I can't do that, I want to do it with as little of my own money as possible.

The main tools I'm using to do this are:

1. An interest only mortgage.
2. Pension as main repayment vehicle, so tax relief and investment growth pays for the mortgage and I get back all of my own net money.
3. S&S ISA investing for anything the pension doesn't cover.
4. Learning about investing and pensions so I can use those tools better, to save me money.

Those methods require looking beyond just the mortgage term, to include retirement income, early retirement and such in the plan, so you can exploit the tax relief and make the money do more for you.

When I took out my mortgage I didn't need it. I had the money to buy with cash. I still do and could do it whenever I like. I didn't do it because it would compromise my other goals and be less efficient than being patient and waiting for a pension lump sum. Around December 2010 I reached the point where I could live for life at a reasonable level and clear the mortgage. Not yet with enough safety margin, but it's a good start and now I have less reason to worry about long term illness or losing my job, and still get to take care of clearing the mortgage. It took me about five years of saving and investing more than 60% of my net income to get to this point.

I like the idea of paying off my mortgage with free money and I'm patient and willing to do long term planning.

jamesd

Reserved for future use 2.

jamesd

Reserved for future use 3.

jamesd

While many ways to become mortgage free efficiently involve investments, here's one to start that has almost no investment risk.

Assumption for this one: you're a 50% tax payer and are at least 55 years old. This means that you can pay money off your mortgage free and may be able to come out of it with more money than you started with. Not many of us are 50% tax payers but it's a fun start.

The key to this one is pension contributions.

1. Contribute £15,000 of after tax money to a pension and you get £15,000 income tax relief so you end up with £30,000 in your pension pot. Remember that the limit is £50,000 into the pension a year unless you have some allowance left from past years.
2. Since you're 55 you can immediately take your pension commencement lump sum. That's £7,500 and leaves £22,500 in your pension pot. Use the £7,500 to clear some of your mortgage.
3. Now you have £22,500 in your pension pot. If you don't know what to do with that you can buy yourself a level single life annuity that will pay a 55 year old man £1,258 a year or a woman £1,192 a year. After twelve years or so you have the other £7,500 of your initial money back and an ongoing free income for life. If we can believe that the 50% rate is temporary you'll get a tax arbitrage gain when your rate drops back to 40%.
4. If you can't afford the initial £15,000 why not add it to your mortgage? The annuity income will clear the extra £7,500 of borrowing, after the £7,500 initial repayment, soon enough.
5. If you're willing to take even a little investment risk, you could consider buying inflation-linked gilts, UK government bonds. Then use the maximum GAD drawdown amount each year. That's currently £1,238 for a 55 year old man or £1,170 for a 55 year old woman but increases with age so it'll soon be higher than the annuity income level. You'll get your money back faster, but may run out of money before you die. That's fine in this case because the purpose s clearing a mortgage efficiently, not providing lifetime retirement income.

All of that assumes that your employer doesn't use salary sacrifice. If your employer uses salary sacrifice and pays the employer NI into your pension pot here's how it looks:

Reduce your salary by £30,000, £15,000 net after top rate tax. 2% employee NI and 13.8% employee are also saved for a total of £34,740 into your pension pot. You get back £8,685 of your money immediately and an ongoing annuity income at 55 of £1,457 for a man or £1,380 for a woman. It takes nine years to get back the remaining £6,315 of your initial £15,000, then you have the annuity money as an ongoing free income for life. And you can use that for more mortgage clearing.

jamesd

Not many of us are top rate tax payers so later I'll put the calculations for higher and basic rate in this post.

GeorgieFTB

James

I think your ideas do have merit, ohh that sounded less patronising in my head sorry, and I will be reading this thread to see if I can pick up any tips but I am one of those 'wasteful' people that try to make regular overpayments...

I'm a single mother of two small boys, my time is precious, and I would much rather spend time and effort with my kids than thinking up elaborate ways to screw the government/business out of some money.

The pension idea above falls into the category of matched betting for me, seems like a good idea, I should look into when I have the time to really understand it and think about it but that isn't going to happen until my kids don't need me so much.

Sometimes regular overpayments is the most efficient use of my money. I respect your views, in fact, I welcome them, and I would thank you to respect others views on this board.

Gx

PS: one little thing, in the above calculation there is no mortgage interest, I'm assuming a 55yo high rate tax payer would have a larger house, with possibly a large mortgage. The interest payments from not plowing the money straight into the mortgage needs to be calculated to compare like for like.

jamesd

GeorgieFTB, yes, the interest is something to consider. Above age 55 it's only a year's worth, less savings account interest, because you can do the pension buying and income taking most efficiently once per tax year, just before the end of the tax year. So instead of doing monthly overpayments you put them into a savings account, then near the end of the year into a pension and immediately do what I described. There's even a tool for it, called an immediate vesting personal pension: you hand over a chunk of money and you get back the lump sum and the ongoing annuity income with just one transaction and a refund claim to HMRC.

Addressing the interest cost for younger ages will involve some investment risk, even if only savings accounts, so that's something I'll write about later because quite a few people will find that less interesting than what's effectively easy free money without significant risk by doing it once you're 55.

I've looked at matched betting but thought that it would take more time than it's worth for me, compared to other ways I could spend my time. For those who are old enough pension games take less time. I'm still interested, though.

Don't worry about seeming patronising or not. I've probably irritated quite a lot of people who are more comfortable with regular overpayments. We're all different, and like different ways of doing things. Just pick what you think works for you and enjoy any benefits you get from it. If you like repayments, go for it. It's not a fight, just ideas that may be interesting to make the money go further.

Lois_E

Well, I shall read your suggestions with an open mind, but since I'm nowhere near 55 and only a basic rate taxpayer, I'm afraid you're not hitting the spot for me just yet. I'm already aware that if you can get savings at a higher rate (after tax) than your mortgage then it makes sense to put the money in there rather than make OPs, at least until the IRs change, but it's always worth saying for any new people, so thanks for that.

jamesd wrote: »

Addressing the interest cost for younger ages will involve some investment risk...

Now, I'm a rather risk-averse person financially. I remember years ago, when I was still at school, my older brothers were all being told that making capital repayments on a mortgage was a stupid waste of money. Much better, they were told, to be IO and have an investment vehicle to pay off the principal at the end of the term. I didn't like the sound of that. I thought at the time that if I was grown-up enough to have a mortgage, I'd like to be making straightforward repayments that I could understand and feel in control of. Years later I looked back and remembered thinking that, when I heard from my brothers that they were getting letters explaining that their endowments weren't going to come anywhere near covering their mortgages.

Good luck to you, jamesd, and I hope your plans work out. (That's intended literally not sarcastically, in case anyone's wondering.) However, I'm sticking to repayments and savings accounts and things I can understand and control.

jamesd

I do take your wish of luck literally, thanks. Fortunately the current options are far more transparent than endowments but I agree that many people won't like the long term investing approach. Maybe they can still benefit from the almost risk free approach that is available after 55 though. It's why I started out with something nice and safe.

elantan

Had written a long reply but lost it


Basically I was saying thanks its great to hear of different ways to achieve the same thing ... I look forward to your younger basic rate ideas