Should I pay off my mortgage? How do I calculate?

Alice_B

I've got a mortgage for approx £65,000 on a fixed rate of 6.05% until September 2009 (21 months). I will soon be in a position to pay this off.

The redemption penalty is 1.5% + £90 if I repay the loan before that date, which is about £1000.

I can make overpayments of £500 a month without penalty, which is £10,000 total over say 20 months, before I repay the remainder of the balance.

IceSave is currently offering 6.7% credit interest for a 1-year term, gross. I am a tax payer.

If repaid the loan, I would also earn approx £500 a month in rental income which is currently covering the mortgage payments. I could put this in the bank and earn interest on it.

I haven't the faintest idea how to calculate what would be the best option for me!

a) Repay the loan immediately, pay the penalty and save on 21 months interest charges.
b) Repay 20x £500 without penalty, bank the rest of the money and repay the loan after 20 months with no penalty.
c) Do something else with the money until September 2009!

Any ideas how to calculate this? I would be very grateful for any help!

Thanks
Alice

Jonbvn

To give an exact answer you also need to specify the remaining term of your mortgage, your current monthly payments and advise whether it is a repayment mortgage or interest only. This is necessary for amortization calculators.

Even without the above information, I think option b) is best for the following reasons:

1. No penalties.
2. Gross (before tax) savings rate of 6.7% is equivalent to 5.36% after tax, which is less than your mortgage rate.

Alice_B

Thank you Jonbvn, I was hoping someone would reply! I thought there would be some info I had missed out.

The remaining term is 21 years. It is a repayment mortgage.

Another benefit to making the regular overpayments is that I could then borrow back that money and also have cash in the bank if I needed it - for example, for a deposit on another property if we need to move house.

Whereas if I paid off the loan and owned the property outright (which is rented out, I live elsewhere) but then I wanted £50k for a deposit to move house, I would have to remortgage the property again from scratch to get my hands on that money, which would be complicated and there are admin fees etc.

It is becoming clearer in my head now! What does anyone else think?

Jonbvn

Alice,

Given that the property in question is rented out, paying-off the mortgage may not ideal, since you can use offset the interest payments against the rental income for tax purposes.

Alice_B

That is true, I'm new to being a landlord so I had forgotten that aspect for the purpose of this calculation. Again, it's hard to know how to calculate whether the interest saved would be more than the tax spent... I guess this is why people have accountants!