Can someone please explain to me why people pay off their mortgage early?

marathonic

Assume a 25 year old obtaining a £250,000 mortgage over 30 years at 3%. They will pay £1063 per month in mortgage repayments.

Now, let's assume they were able to obtain the same mortgage on an interest only basis. They would pay £625 in monthly repayments - £438 per month less. As a 40% rate tax payer, that person could contribute £730 per month to their pension at a net cost of the £438 per month saved in monthly repayments - leaving them with the exact same disposable income.

If the person were to assume an averge return of just 5%, their pension fund would grow to £607,548. At 7%, it would grow to £890,578. In fact, 7.6% growth would result in a fund of £1,003,554 - enough to use the 25% lump sum to pay off the mortgage in it's entirety.

As you can see from the above figures, 7.6% growth would result in a mortgage that is paid off at the same time as the person who got the repayment mortgage - but with a pension pot of £753,554 in todays money to use for future income.

Of course, returns may be below 7.6%. However, in my opinion, it's not an overly optimistic prediction and, even at 5% return, the person using the pension strategy would be well ahead.

The risk is that rules change or that returns are lower again. However, these are risks that I'm willing to take. If they removed the 25% tax-free lump sum, for example, I'd end up with a higher annual income and could easily afford to continue mortgage repayments - even without a job.

marathonic

Of course, you're always going to get the traditional people who think that overpaying your mortgage is the absolute best thing you can do with your spare money. Whilst this is better than frittering it away, it's HIGHLY unlikely to turn out to have been the best course of action.

By doing the same as everyone else, your finances are likely to end up in a similar position to everyone else - and I for one don't want to plan for AVERAGE finances. You have to think outside the box if you want to get ahead and using the pension approach could see many with a very comfortable, early, retirement.

talexuser

I paid off my mortgage in 8 years, the increase in disposable income then went into max ISA contributions in ~90% of the years afterwards in acc funds leading to a large pot to switch to income when needed. I was in a final salary pension scheme which paid the max 2/3 salary on retirement. Maybe you can't do the same nowadays, and maybe that is why they are saying our children might well be the first generation since the war not to be better off then their parents?

stardoman

Walcott wrote: »

2) Time value of money is fundamental to the exposure of risk of default. Assuming stable employment, the risk of default does decrease with increments throughout a persons career.

I don't think anyone can assume stable employment unless you work for the government. I'm in my forties now and every 2 or 3 years there is a round of redundancies. So every 2 or 3 years we are nervous of what the future will hold.

We overpaid the mortgage and at one point were almost mortgage free. We then decided to have a huge extension built onto our house and our mortgage now is higher than its ever been/

Personally, I would not want to use pensions instead of a mortgage. I can remember a product called a pension mortgage which the mortgage advisor tried to push onto his. He also tried very hard to get us to take an endowment. He told me that 99% of his customers took endowments and that the couldn't all be wrong :rotfl: We didn't take the endowment as I did loads of research and everything I read was pretty negative even then (this was 1994).

If you're young and don't have dependents then the downside of investing going wrong is not going to be as bad. But I have 3 children so security and a roof over my head is my priority.

Also, interest has to be paid on your mortgage. I am currently overpaying and pay £950 per month. Of that, £500 is taken in interest. My mortgage is not huge either.

hyposmurf

Paying it off early gives you more chance of attaining a better interest rate when you remortgage, so better interest rate than someone who doesn't overpay. Another point that I think people miss is that overpaying means you'll likely have less remortgage fees to make.
There is also the psychological posiitves that some people gain as posted above.Having that debt completely cleared gives you a financial milestone that you work towards, saving and investments are more of a continual process.I save, invest and overpay off my mortgage.

System

stardoman wrote: »

I don't think anyone can assume stable employment unless you work for the government. I'm in my forties now and every 2 or 3 years there is a round of redundancies. So every 2 or 3 years we are nervous of what the future will hold.

We overpaid the mortgage and at one point were almost mortgage free. We then decided to have a huge extension built onto our house and our mortgage now is higher than its ever been/

Personally, I would not want to use pensions instead of a mortgage. I can remember a product called a pension mortgage which the mortgage advisor tried to push onto his. He also tried very hard to get us to take an endowment. He told me that 99% of his customers took endowments and that the couldn't all be wrong :rotfl: We didn't take the endowment as I did loads of research and everything I read was pretty negative even then (this was 1994).

If you're young and don't have dependents then the downside of investing going wrong is not going to be as bad. But I have 3 children so security and a roof over my head is my priority.

Also, interest has to be paid on your mortgage. I am currently overpaying and pay £950 per month. Of that, £500 is taken in interest. My mortgage is not huge either.

The whole point of using the assumption is to try to understand how things work. It is obviously assumed that employment will be stable when the bank lends.

racing_blue

2poor4this wrote: »

Currently interest rates are low, why would you not try to pay/overpay your mortgage off now as the future might see interest rates at a level where you can no longer afford the repayments.

I see this as the half-empty-glass approach

Reframe it:

Currently interest rates are low. So it is cheap to borrow money. Why would you pay any of that back, when you could invest the money at a better rate, or put it aside for future opportunities?

bigadaj

It's an interesting debate and one which doesn't have a right or wrong answer irpts down to individual preference.

There isa case for saying we aren't living in normal times and interest rates will correct to normal at some time which provides a different scenario.

However in simple terms most people would be best off by investing rather thn overpaying a mortgage, investment returns are long term around 4-5% in real terms, whereas mortgage interst rates are lower in real terms. This obviously involves risk, but this reduces the longer the investment or loan term. Doing this in a pension obviously offers better returns due to tax relief rather than unwrapped, and there are similar but lower benefits in doing the same in isas.

Many people prefer the certainty and comfort of wholly owning their home, or at least owning a larger percentage of it, and the are incremental benefits in terms of lower interest rates as equity increases.

AlwaysLearnin

My two penneth; perhaps to get a better LTV and therefore lower rate, but I'd say mainly due to risk tolerance and/or security.

If you have a higher risk tolerance or don't feel the need to secure the roof over your head, then go for it and good luck to you. That's not for everyone though.

G_M

Certainly the interest rate being charged by the lender Vs the return you can get elsewhere is a significant factor in any sensible decision.

Personally, however, I believe avoiding or paying off debt is generally a good policy (be the debt a mortgage or other loan).

I over paid on my mortgage as much as I could almost from the start (admittedly interest rates were 7-8% then), and got rid of it in around 12 years.

Around that time I was made redundant and was unemployed for a year or so. I thank god my home was mine and paid off. More recently (but still within the original 25 year term) I've become sick, been forced to take early retirement due to ill health and, again, it's a huge relief not to have money worries