Should you pay off your mortgage early and be debt free?

pay off your mortgage

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In order to answer the question ‘should you pay off your mortgage early?’, it would first help to understand why anyone would want to and outline the potential pros and cons of doing so.

Pros

  • You’re paying interest! For some people, the idea of debt is scary. A payment that is set to come out of your account monthly for a potential 35 years is quite a daunting thought. A mortgage is borrowed money and you have to pay interest on it. Many people buying their first house will usually have around a 10% deposit. So, for a potential 35 years you will be paying interest on hundreds of thousands of pounds! Making overpayments will not only allow you to avoid a ton of interest but also to be mortgage free years early.
  • More money every month! The less money you have coming out of your account over a long period of time, the more money you will have to build your own wealth. The more money you have at the end of each month means the more money you have to put into other investments. Therefore, paying off your mortgage early means you’ll have more money to put towards these investments that’ll allow you to retire wealthier than retiring still owing a large sum on your home. This is what Dave Ramsey has to say about paying down the mortgage:

Cons

  • Money is no longer liquid! There are however some cons of paying off the mortgage early. The biggest one that comes up is that your money is no longer liquid. You cannot easily gain access to your money if you need it as it is now with the lender. Instead, you will likely need to re-mortgage to gain access to this money.
  • It may also cost you extra to borrow on that house later as interest rates may be higher, so you are potentially paying a higher interest rate in comparison to your initial loan.
  • Money may give higher return invested elsewhere! Some believe that investing those additional payments in index funds will produce better returns in the future. If that index averages around 8% return on investment yearly and your mortgage is around 2% interest payment; you’ll be 6% better off investing in indexes. Placing all your money into paying off your mortgage will mean missing out on that sweet, sweet compound interest over time. However, if your mortgage loan to value is high, your repayments and interest payments will also be high.
  • Perhaps paying off the mortgage now would seem silly as inflation would make your mortgage cost less. Say you have £100,000 left to pay on the mortgage – in 10-20 years time, the payments you are making will be less as the pound would likely be worth more than it is now.
  • That additional money that you could pump into your mortgage could be used instead to maximise your pensions and ISA contributions.  It could also be used to save for both yours and your child’s future.

Paying off your mortgage isn’t a simple yes or no

pay off your mortgage

As you can see there are a number of pros and cons to consider when it comes to paying off your mortgage early. Each case will be different from person to person and each person’s comfort level with debt. Some of the things we’ll be looking at before you decide whether paying off your mortgage early is right for you are listed below:

  1. Have you cleared any other outstanding debt?
  2. Have you put aside money for the future?
  3. Do you have the extra money to pay off your mortgage?
  4. Identify priorities.

1. Have you cleared any other outstanding debt?

Before you even consider whether or not to pay off your mortgage early, we need to identify any other debt you may have first. Currently mortgage interest rates in the UK are extremely low (average in the UK – no more than 3.4%! It is however possible to get as low as 1.5% on a fixed rate mortgage). If you have credit card debt, loans or car payments, these should be paid off in full before tackling your mortgage. These can sometimes have high interest payments. One of the key areas to building wealth is to stop giving away our income every month. The more money we have in our pockets after payday the better off we’ll be in the future.

Student loans

You need to consider carefully whether to pay your student loan off or not in the UK. I know the idea of paying out money every month means you save less each month. Consider though, most people starting a career out of university are unlikely to earn enough to pay off their debt. From the point of eligibility (currently earning above £19,390 for plan 1 and £26,575 for plan 2) students are given between 25-30 years of allotted time to pay off their loan. After that period the debt is written off and you are student loan free. Regardless of the interest you are paying now, you wouldn’t have managed to have wiped out the total amount with your wage. In this case paying off the full loan would be unnecessary. The only way I would say this would be worth it was if you were following the steps from investing in your child’s future.

However, if you are on a high income, you should pay this debt off as quickly as possible to avoid all the extra interest. I calculated that one of my loans had around 5% interest on it! I’d recommend removing this quickly.

Debt is something loads of people have and eliminating it is something most of them struggle with. We live in an age where the media easily convinces us of the things we need. Often, we fall for these things – including me. Find out how to remove debt and follow the 7 simple steps on this previous post: 7 steps to removing debt. The key is to ensure that all bad debt is paid off before considering whether to pay off a larger sum of your mortgage.

2. Put aside money for the future

Have you put aside 3-6 months of expenses?

pay off your mortgage

As good as it would be to start paying off your mortgage, it probably wouldn’t be wise unless you had an emergency fund. JL Collins, the author of ‘The Simple Path to Wealth’ advises to have 3-6 months worth of expenses available – he coined this as ‘F U Money’. This money should be used in case of an emergency, such as losing your job etc. Having this fund makes it possible to avoid having to borrow money on credit cards and from loans for emergencies. The readily available (liquid) cash is no use to you tied up in your house or even in the stock market. In fact, this money could even be useful if you have had a baby and your maternity pay isn’t enough to pay your expenses. Maternity pay in the UK sucks! I earned more when I was 13 doing a paper round than I did on the last month of leave! This idea of ‘F U Money’ saved our bacon during this time.

Have you put money aside for your retirement?

retire wealthy

You don’t want to be eating cat food in your retirement! Make sure that you are putting money aside every month into your workplace pension and/or your private pension. This is especially important if your work is contributing to this pension; make sure you max this out and collect as much money from them as possible. Don’t pass up on free money! This is also a fantastic opportunity to decrease the amount of tax you pay, as this money comes out before tax. If you don’t pay into your pension, you could be paying 20-45% extra in tax on that money coming out depending on your income.

You could also benefit from paying into a stocks and shares ISA. This allows you to invest up to £20,000 a year without paying any tax or interest on this money. To not pay into this would mean missing out on that sweet, sweet compound interest I mentioned earlier! Ideally, I would say at least 10% of your monthly income after tax. However, this can be adjusted depending on how much you pay into pension.

Do you have dependents or are expecting a child?

This step should work concurrently with steps 2 and 3. Ideally, you should be putting aside money for your children every month. Have a read of this post “how to invest in your child” for more information. Paying off your mortgage early, in my opinion should happen concurrently with putting money aside for your child’s future. As soon as you have paid off your mortgage, you will have more money available monthly to invest in your child.

3. Do you have the extra money to pay off your mortgage?

If you earn a decent wage, have no debt other than your mortgage and are careful with your expenses, the simple answer should be “yes” – there should be money remaining at the end of the month available to you. This may not be in one lump sum, but you have the potential to make overpayments monthly. Most fixed or variable rate mortgages allow you to overpay by around 10% of the outstanding mortgage value a year. However, if you’re the only one paying this mortgage, it may be quite difficult to make the full 10% each year.

If you had £100,000 left on the mortgage, you could pay £10,000 back in overpayments throughout the year. With a repayment mortgage with a decent interest, you would be paying back around £500 monthly, plus the overpayments £833 extra a month to pay this. If you are living in a house with a partner, that’s around £667 a month each for mortgage. Whilst alone, that’s £1,333 which is a little more difficult.

Be sure to check with your mortgage provider before overpaying as you may incur high fees for paying too much.

4. Identify priorities.

Having looked at the pros and cons of paying off your mortgage early, it would make sense to think carefully about what your priorities are at the current stage of your life.

Stage of life

I spoke to a landlord who said that when he was younger, he would religiously overpay his mortgage by around £1,000 extra a month! He wanted to have the deeds of his houses. Now that he is older and has children, his priorities have shifted and now is more focused on investing in their future. This could be saving up for private school or setting aside for their university fees. It could also be moving to a bigger home in a better area that would allow his children to grow up in a safer environment with plenty of space and freedom. So, this particular landlord went from religiously paying off the mortgage to paying the minimum amount on an interest only mortgage to free up some of his money.

Buying a second home / Buy to Let

Based on my interviewees, some don’t want just one house, they want many – in order to invest their money in properties that will produce an income. For these people, paying off the mortgage in full may not be their end goal, at least not right now. In order to amass as many properties as possible, many people believe that they would need leverage to help them purchase these homes. When you live in London and the property prices are exceptionally high, it will take a long time to save 25% deposit for a £600,000 house. I know it would take a while for most people on the average London salary of £40,000 a year before tax. For most people, the only way to get ahead is to leverage their house in order to have enough money to put down a deposit on a second house.

How does this work? Over time the value of your property will go up. You will then re-mortgage your home to borrow money from the bank to buy a new house. You then end up paying back that additional money. It would however be a good idea before purchasing the next property, to overpay your mortgage each month, bringing down your repayment/interest payments. You will also have more money in your pocket each month as the payments will slightly go down each time you overpay.

If you want to try and build more wealth, make sure you use the rent from this new property to make overpayments on both the new house and your current house. I wouldn’t worry about using it as income yet, first clear some of that debt.

Investing more into retirement

If the interest rate on your mortgage is low, you will get a better return investing that money into your retirement. This could be adding additional money into your pension or yours or your children’s ISAs. It is definitely important to plan for your retirement. There are however, two things to consider:

In 1979 there was an interest rate of 17%! That is crazy! From 1971 – 2020 the interest rate has averaged around 7.36%. 

Using the example above with £150,000 deposit on a £600,000 house your mortgage at 2% would be on a repayment that would be around £1,907 a month and interest only £750. If the interest rate went up to 5% the repayment would be around £2,631 and interest only £1,875. I would be kicking myself that I hadn’t been paying it down more viciously when the interest was low. You are now losing a ton of money each year (£22,500 in interest payments instead of £9,000).

Current interest rate of the mortgage and the term remaining

If the interest rate is high and you have a lot borrowed, you should definitely be overpaying your mortgage in my opinion! The more you owe with higher interest will mean you giving away a ton of extra money that could be going towards other investments.

If the mortgage term is close to ending and you are not close to paying it off, you should be making those overpayments as a matter of urgency, unless you intend to re-mortgage against the equity of the property. Hopefully, you have thought through your reasons as to why you would want to re-mortgage.

Conclusion

At the end of the day, whether you pay your mortgage off early is up to you. The majority of homeowners I interviewed in preparation to writing this post either have made or make overpayments on their mortgage depending on their situation and stage of life. Some would say it depends on interest rates and others believe in leveraging as much as you can from your home to invest elsewhere.

There are pros and cons to both… but, ultimately, the choice is yours…

Please comment, share and like this post. It would be great to spread the word and help us all on our journey to become debt free! A little extra cash in our pockets never hurt anyone.

1 thought on “Should you pay off your mortgage early and be debt free?”

  1. Rita Da silva

    Intresting post Alex, very informative and easy to understand and follow.
    I know that paying into the morgage is a good idea as the intrest that the bank charges on the borowed money is usually higher than the intrest you will get if you have on a savings account.
    keep up the gopod work .

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