Pay off early or wait???

adepick

Hi, I'm a first time visitor and could do with some opinions to consider.

Background - By 1 May 2013, I will have approximately £42K outstanding on a property currently worth about £225K. I am on a 5 yr fixed rate repayment mortgage (followed by one year at SVR) that was taken out in Jan 2011 at 4.39% and my repayments are approx £1K per month - I opted to pay my mortgage off over a short amount of time, hence the repayments are high, but I'm content with that. The property is currently rented out and earns me about £721pm.

My question - I will be in a position to pay off the £42K plus the 3% early penalty charge (roughly £1.2K) in May and be mortgage free, but is this the right thing to do? I have no other debts, no CC bills, and the money I will use to pay off the mortgage is currently earning 2.75% before tax. I'm a 40% tax rate payer. If I pay off early I will be £1K per month better off, but I will lose about half my savings and the benefit of offsetting about £3.5K per annum against the tax I pay on my rental income.

I can see benefits to both paying off and waiting.......help!

adepick

Lois_E

I tried to do some calculations to work out what's best for you to do, but your numbers don't seem to add up to me. If you've borrowed £42k at 4.39% and you are paying it off at £1000 pm, it'll be all gone in less than four years, so I'm not sure how your 5 year fix followed by a year at SVR applies.

adepick

No, I borrowed about £80K on a 5 year fix, but I've been over-paying by 10% per annum for the last 2 years (the max allowed), and the rest has been paid off as it is a repayment mortgage.

adepick

Lois_E

Oh I see. That makes more sense. Sorry I didn't read your post more carefully. I'm off out soon for the evening, but if nobody's done any sums for you by the time I get back, then I will.

adepick

Thank you!

Lois_E

So you have 3 years left on your fixed rate. We have no idea what the SVR is likely to be in 3 years' time, so let's guess it's the same 4.39% as a first approximation. If you keep paying £1000 pm, you should pay off the whole lot in 45 months, paying about £3,600 in interest over that time.

Meanwhile, your £42,000 will be earning compound interest at 2.75%, taxed at 40%. Over 45 months, this earns a total of £2,660 in interest. Therefore if you leave things as they are, you end up paying out £940 more than you bring in.

On the other hand, if you pay it off immediately, you pay £1,200 in ERC. Then you also have to pay tax at 40% on the whole of your rental income instead of offsetting the mortgage interest bit. You therefore lose the opportunity to offset the £3,600 interest you would have paid, increasing your tax bill by 40% of this, which is £1,440.

You can then save your £1000 a month, presumably also at 2.75% taxed at 40%. Over the 45 months, this will build up the £42,000 capital amount to replace what you took out of your capital to pay off the mortgage. It also accrues some £4,400 of interest.

If I've got my calculations right, then at the end of the 45 months, you have brought in £1,760 more than you have paid out.

It seems that paying off early makes you end up begin about £2,700 better off after 45 months than you would be if you left things as they are. But my calculations may well be wrong. If any other poster would like to check my numbers and either confirm them or explain what I've messed up or missed out, I'd be grateful.

PS I know you don't get the money until May, and to make it easier I did the sums as if you could do it now. So if you wait until May the benefit won't be quite as big. I don't think it'll make enough difference to swing the balance, though.

adepick

Brilliant! I'll analyse these figures right now - thanks for the advice!