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My path to financial freedom: overpaying the mortgage

Michelle McGagh's no spend year made her realise she could cut years off her mortgage, opening up new possibilities.

 
My path to financial freedom: overpaying the mortgage

‘I bet you go on a mad spending spree when it’s finished’ was a common phrase I heard during my no spend year.

People assumed after a year of not buying anything I’d be rushing out to the nearest shopping centre to blow the lot on a designer wardrobe. And while I did need to replace some well-worn, and worn-through, pieces of clothing the end of the year was not the shop-a-thon many predicted.

You see, I didn’t actually have a massive pile of cash to splash. I’d been doing something much more sensible (and some have said boring) with the money I wasn’t spending: I was overpaying my mortgage.

I live in London and mortgages aren’t small; my own was just a shade over £230,000 at the start of the challenge and over the year I reduced it by nearly 10%.

The majority of people fell into two camps when they found out what I’d done with the cash.

Firstly, those who didn’t know you could overpay and secondly, those who didn’t know why you’d want to.

The first group are easier to deal with than the second in my experience!

Overpaying isn’t something the banks like to shout about because it means less money for them. Typically you can overpay around 10% of your mortgage a year, or £500 per month (although you should check the terms of your mortgage for details).

By overpaying your mortgage you are chopping down the number of years you need to keep paying for it and reducing the amount of interest you pay over the term of your mortgage.

Let’s take the example of a £200,000 mortgage over 25 years on a rate of 2%. On this deal you’d pay £848 per month for the next 25 years (assuming you stay on the same rate, of course).

Now let’s look at what happen if you overpay your mortgage. So as well as paying your £848 a month, you overpay an extra £200 - a total of £1048 a month.

Doing this would mean you pay off your mortgage three years and three months earlier and it would save you £7,648 in interest over the term of your mortgage. That’s quite a saving.

The monetary saving is a good way to answer those who ask why on earth you’d overpay. Who doesn’t want to save over £7,000? Personally, the less money I can give to the bank the better.

But the idea of overpaying for me is bigger than just making a saving. I want to knock years off my mortgage because I don’t want to be obligated to work all the hours God sends just to pay it off.

Yes I need somewhere to live, and yes I’m grateful I’m even on the property ladder but I don’t want my whole life to revolve around my mortgage.

By paying off my mortgage early, I’d get rid of my biggest outgoing and would only have to cover my bills, food and spending money (and we all know I can live on a tiny amount!). If I only had to cover these costs then I could work far less, I could maybe even work half the year and volunteer or travel or do something other than the 9-to-5.

Surely that’s really living?

It’s not going to happen overnight. It’s not even going to happen in the next five years but at age 34 I feel I’m able to see a way out of the office treadmill that so many of us are on.

If giving up treats and luxuries, and cutting back my spending will help me make the giant leap to financial freedom, then that’s a price worth paying. 

21 comments so far. Why not have your say?

mike mcdonnell

Mar 03, 2017 at 11:14

This is what should be taught in schools..and " uni " you could have a gap year too !

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Micawber

Mar 03, 2017 at 14:05

Quite right. The key test is whether you can get a guaranteed better rate of interest on some other investment, than the rate your mortgage costs you. Or if you have some other loan at an even higher rate, that should be paid off first. An exception might be your mortgage in times when inflation is high and rising (when you could argue that borrowing more, to buy a bigger house or other appreciating asset, makes more financial sense)

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Davos

Mar 03, 2017 at 14:10

More and more these days people are financing a lifestyle they cant afford by taking on liabilities that their salaries allow them to. Be it cars, mortgages, credit cards. People then spend their lives working to pay off their debts all the while taking on bigger liabilities as their credit extends with their salary uplifts.

The next result is a life on the hamster wheel never actually owning anything outright. The only exception to this is a mortgage where a long term loan can be beneficial whilst capital is raised elsewhere at a better rate than the lender is charging. Your main residential property is not an asset, it is a liability whilst it is still mortgaged.

NB. Wealthy people dont have liabilities. They dont buy things they cant afford to own outright for cash.

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Raj K

Mar 03, 2017 at 15:51

Davos would that apply to the people who made their wealth via property who often bought with leverage and never actually owned all of that property. Many of them are wealthy souls today?

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Davos

Mar 03, 2017 at 16:00

Raj K

Well of course it's a little different if you use the infrastructure and make it your business. It's a risky business however and it levering up hasn't been a fairy tale for everyone.

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Michael Loveridge

Mar 03, 2017 at 18:07

"NB. Wealthy people don't have liabilities. They dont buy things they cant afford to own outright for cash."

That's not actually the case. Most wealthy people who are, for example, buying a £200k car will buy it on finance.

The reason is that they can borrow at around 2-3% while enjoying a return on their capital of several times that rate.

This is why wealthy people are different - they can obtain returns on their investments that are well above their cost of borrowing, whereas for ordinary people the cost of borrowing almost always outweighs any realistically available investment returns.

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Slickness on

Mar 03, 2017 at 19:06

Michelle, there is another significant advantage of overpaying your mortgage. You are, in effect, building up an ever increasing overpayment and if needed you can then draw it back down again. I did this, and after a few months I viewed it as a cheap ASU policy (Accident, Sickness and Unemployment cover). The cash was always there in case I needed it, without having to either hold a separate emergency cash sum on deposit Ina bank account earning no interest, or having to pay premiums for an ASU policy that I'd probably never need.

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Chris Phillips

Mar 03, 2017 at 19:45

I had an interest-only repayment mortgage in the days when you got mortgage interest relief (happy days!) tied to an endowment policy). That, as we all know now, was a disaster waiting to happen. I switched to paying off capital as well as interest, but in my mid-50s it looked as though I wouldn't have paid off the mortgage by retirement. Then I added £20,000 to the mortgage to buy a wood - everyone said I was mad, but it was something I'd always wanted to do. Seven years later I sold it at a fourfold profit to pay off the mortgage and cashed in the endowment. I guess that's not good financial planning - just good luck.

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Davos

Mar 03, 2017 at 20:18

@Michael Loveridge

Good point well made, although I suspect the people we are talking about could indeed afford to buy the asset outright if they wished.

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Mr J

Mar 04, 2017 at 11:04

Slickness,

That has also been my approach but not by relying on being able to draw back mortgage overpayments. I think the problem with giving all your money to the mortgage company in overpayments is that you may find you can't actually draw it back in times of need like loss of job. This is quite likely to coincide with bad economic times and the lender tightening up on its credit risk and therefore refusing to let you draw down again now that you have no income.

My approach has been to invest savings in ISA (and SIPP) to pay off the mortgage when the time comes and to temporarily draw upon in any time of crisis/job loss. No lender can withhold this money from me if I need it. Over 25-30 years it should be possible to earn a greater rate of return on these investments than the mortgage interest rate. It obviously requires some discipline to take this approach - effectively an ISA mortgage - which is really today's equivalent of the endowment mortgage approach without the greedy salesmen and endowment companies. There is some risk to manage, but hell, life is risky and you ain't gonna get out of it alive!

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Slickness on

Mar 04, 2017 at 12:24

Quite a prudent approach Mr J. I should have said that I do have first hand experience having worked for a building society and so have seen this operating first hand. The T & C's of your mortgage are obviously contractual and so if they allow you to draw down overpayments they cannot stop you doing it. They may ask you why you need the money, but you are not a liberty to tell them. I take your point though and there is a general mistrust of financial service providers and mortgage providers. Mutuals in my opinion are much more considerate of your personal circumstances and will, only as last resort look to repossess the house. The best advice would be not to ignore the problem and to work with them to find a solution. If you are already two months in arrears, it is almost too late and the outcome from both a bank or a building society would normally result in repossession. Drawing down overpayments can buy you time, when you perhaps need it most. Talking to your lender ( I can only comment on mutuals however) repossession would be a last resort and they would consider extending your loan term or allowing payment holidays to help you get back onto your feet. I accept that banks can be far less accommodating though.

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Mr J

Mar 04, 2017 at 14:21

I rather suspect that most lenders will have t&c's which will allow them to vary the initial contract terms. Here is just one example...

http://www.thisismoney.co.uk/money/mortgageshome/article-2241410/Offset-mortgage-borrowers-warned-overpay-lenders-shut-door-releasing-funds.html

Saving into Stocks & shares ISAs and SIPP also makes use of these annual allowances which are otherwise lost forever. Later in life you may find yourself receiving large lump sums like redundancy payments, pension cash, inheritance, insurance payment, court claim settlement, or money released by downsizing or property sale. If this happens you can pay off your mortgage and keep your savings in ISA and SIPP wrappers with their tax advantages. If you had already paid off your mortgage you would find yourself taking many years to move the lump sum into ISAs.

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paul kaye

Mar 05, 2017 at 11:05

Overpaying by £200 month will be a wrong move .

I would Invest that £200 month into say 4 funds with say Legal&General or a woodford fund and I bet you any money over 25 years you will have more like £40000 yes forty thousand not £7648 ! really looking to save just £7k over 25 years is a joke.

I have done this my self.I saved only £100 month for 10 years with L&G managed fund,left it for another 10 years and cashed in at over £45000 !!tax free!

At a cost to me of £8500 (as In those days I had tax relief on the £100 so in effect paid £85 month.

Today you have isas,so do it via an isa and look forward to much more than £7K !!!!!!!!!!!!!! yes there are risks,but over 25 years! really,its a no brainer !

Markets go up and down ok,but this is long term, 10 years is considered long term,25 years is a no brainer I repeat. DO it !

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paul kaye

Mar 05, 2017 at 11:29

added comments to my previous.

it is claimed you save £7k interest and 39 months of £848 = 33k plus £7k =40k

saving the £200 month for 25 years= £60k ! thats without investing you can make figures say lots of things,but given the choice investing that £200 month will make you more than you save.

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Slickness on

Mar 05, 2017 at 13:44

Hi Paul, I've effectively done the same thing also. Paid interest only and invested the capital element to IT's over the last 10 years. This just gives you so much more flexibility if circumstances change. Even if you don't have the spare cash, it would be worth extending the term of the mortgage to reduce the monthly premium, allowing to invest the difference. Again, I have done this but also had the benefit of interest only loan availability too.

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paul kaye

Mar 05, 2017 at 14:04

thanks for comments,

I am a firm believer in saving /investing

I treat investing as a monthly bill and set up standing orders/debits.

Time goes quickly and before you know it you have thousands saved/invested

I started investing 3x£100 in OCT 2016 in three different funds,thats £1500 plus growth already and I did'nt really miss it ! thats upto FEB,March will see this £1800 plus growth showing over 3.5% try saving that into a bank and getting next to nothing!

I use my isas and have built up a share holding too over the last 20 years.

My aim is to pay off my but to let mortgages asap.

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Rick Sure

Mar 05, 2017 at 14:32

I changed to an off set mortgage and paid it off in sixteen years, it was one of the most wonderful feelings I have ever had however after a few years of saving at high interest rates until the Icelandic banks crashed I started into Buy to Let with mortgages ten times as big but the rents paid for them and left a healthy profit every year also an excellent capital increase on the property values which I am slowly selling after financeing my retirement for the last 12 years, 71 now and spending winters in the warm and not drawing on my SIPP that is performing fairly well, can't claim it was financial planning, just gut reaction and a lot of luck

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paul kaye

Mar 05, 2017 at 14:39

Rick, well done mate,you are a .shining example to many.

Shame this government are punishing us landlords who have worked and saved hard.Only to be robbed.

I have more respect for Bank robbers! at least they have guts !!!!!!!!!!!!!!

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Martin Savage

Mar 06, 2017 at 08:41

One point the above posters have missed regarding investing the overpayments rather than paying off the mortgage directly at the time.

That old adage "Investment returns are variable and not guaranteed"

Yes you may well exceed the returns you get by investing them separately.

But some more cautious folks like myself, or thosewho perhaps don't have time or aren't expert investors like those on this site, want a bit more security where the roof over their head is concerned.

Overpayments on the mortgage are guaranteed to reduce the outsanding amount, time taken to pay it off and total interest paid. Some would argue that's a price well worth paying for the peace of mind.

Who knows if there will be a stock market crash, with world events in such an unstable and unpredictable state?

Yes, I also know the old adage "You've got to speculate to accumulate".

But I would argue the aim of Michelle's overpayments is largely about future security. She's doing just the right thing in my view.

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paul kaye

Mar 06, 2017 at 10:19

I like all the comments and yes Martin,I agree also with you.

Options are well worth considering however , and I can only go from experience.

Yes there are crashes in the market,but they always come back stronger.

Over 25 years its a no brainer for me.

I know many people don't like risk and I respect that very much.

I do feel that if I had not taken risks,I would not be mortgage free now and still have a pot of money and buy to lets.

Everyone should go with what they feel happy with.

I have always been a risk taker/gambler, in my case,it has paid off.

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quesera

Mar 06, 2017 at 18:28

I love having a mortgage. My borrowings are at 2% pa and I invest in investment trusts with a yield averaging 4% (plus a bit of capital growth with luck). I know I'm 'leveraged' and that increases my risk in a catastrophic downturn. But being mortgage-free holds no excitement for me.

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