Money: It's all downhill from here

Paying off your mortgage early leaves you free to spend more on enjoying life.

The idea of paying our mortgages off early is one that most of us have entertained. And why not? It offers the opportunity of doing more exciting things with the cash. And, at last, there are growing signs that home buyers are recognising this fact. Increasing numbers of borrowers are asking for shorter mortgage terms than ever before.

They still want a good deal - such as an attractive fixed rate. But, just as importantly, they want the flexibility to decide exactly how long they will pay this mortgage for. An ideal loan would combine the two options.

The good news is that it is far easier to shorten the life of a home loan than you think. While it may cost a little more in the short run, setting aside an extra pound or two a week can lop months, perhaps years, off a 25-year mortgage term, saving you thousands of pounds of interest in the process.

The reason for these potential savings are simple. Whenever we take out a home loan, we agree to pay it off at a certain rate of interest. Over a typical 25-year term, the total amount of interest that must be repaid can be triple the sum originally borrowed.

Take an pounds 80,000 repayment loan. At variable rates of 7.7 per cent, monthly payments are pounds 592.57 and the interest payable over 25 years is pounds 113,025. Simply by paying an extra pounds 10 a month the interest saved would be pounds 6,641. The repayment period itself would be reduced to 23 years and eight months.

Paying an extra pounds 30 a month towards the same mortgage would bring interest savings of pounds 14,657, reducing its term to 21 years and 10 months. An additional payment of pounds 50 cuts the term to 20 years and four months, saving pounds 20,983 in interest.

In fact, one relatively unexplored concept among borrowers is that of early mortgage repayment as an investment in itself. Paying a mortgage more quickly is equivalent to earning the same rate of interest as the amount actually charged on the loan itself - tax free.

So, repaying an 8 per cent variable rate loan becomes the equivalent of earning 10.56 per cent gross for lower-rate taxpayers, or 11.2 for those on a higher marginal rate.

Many borrowers may have taken out a 25-year endowment policy or may have made sizeable contributions into a pension, on the assumption that the 25 per cent tax-free lump sum will be enough to pay off the loan at retirement. They assume that, having made the decision several years ago, they have to live with it today.

However, with annuity rates falling as they have been, people would be better off using all their pension fund for retirement purposes. As for endowments, it still makes sense to keep on paying into one until it matures. Instead of linking it to the new mortgage, borrowers can choose a traditional capital and interest option. The policy will still produce a large lump sum - but now it can be used for any purpose, not just to repay the loan.

As interest rates fall, so does the monthly cost of a mortgage. In turn, this means that, if we could afford to keep payments at the same rate as before, the loan is repaid that much faster.

It also makes sense to take advantage of falling long-term interest rates - fixed mortgages are now lower than they have been for three years.

Many of the most flexible loans are offered by lenders who calculate interest payable on a daily basis rather than once a year, which means that any payments are instantly credited to your mortgage account. Among the best flexible loan providers in the market are Standard Life Bank, Legal & General, First Active and Virgin One. The last two offer full banking facilities as part of the mortgage, meaning that you can treat the loan itself as a bank account.

FirstMortgage, the telephone-based home loan provider, has another solution. The company has a 5.75 per cent fixed-rate deal. The difference is that it can be selected for any period between five and 15 years. In effect, you choose the period you want to pay the loan back over. This loan is not quite so flexible as the others, but it makes up for it by its cheap rates.

There is a price to pay for ditching a loan part-way through. Redemption penalties are 1 per cent for each year of the mortgage term, with 5 per cent payable at any time in the last five years. So, a 10-year repayment period starts with a 10 per cent redemption charge, falling to 5 per cent in year five and thereafter.

However, the penalty is on the amount still owed; if you have paid back a huge chunk of the loan already, the redemption will be correspondingly smaller.

Some people assume that early redemption penalties will negate the benefits of making even part-repayments of a fixed loan. But this need not be so.

For example, a fixed-rate mortgage of 5.75 per cent for the last five years of a mortgage has a redemption penalty of 5 per cent of the amount paid. If, say, someone wanted to part-repay a pounds 10,000 lump sum after three years, they would incur a penalty of pounds 500. However, the interest saved would more than compensate for that loss.

Over the remaining two-year period at 5.75 per cent, the saving would be pounds 1,150. On a 10-year mortgage, the cost of the same part -repayment, also after three years, would be pounds 700. But the interest saved in the remaining seven years would be pounds 4,025.

In all these cases the motivating factor is what else you might be doing with your money if it isn't being used to pay off a monthly loan. And most of us can think of quite a few things to do with it.

`The Independent' is offering a free 36-page `Guide to Flexible Mortgages', sponsored by First Active, with tips on all aspects of home loans, including how much you can borrow, how to repay it and a list of useful names and numbers. Call 0800 550551 or fill in the coupon on this page