Money: Readers' Lives - Will it pay to pay off the mortgage?
Using windfalls to bring down a home loan ... after the fixed rate ends on a mortgage ... when to buy an annuity. Your queries answered
Sunday 01 February 1998
Whether you use spare capital to make a partial capital repayment of a loan may depend as much on your psychology as on pure financial considerations. Many people would take any opportunity to get rid of medium- and long- term debts. Others would like to have some rainy day savings and maybe even some investments, notwithstanding that they are up to their necks in debt.
In some cases, the financial case for repaying debt is clear cut. Do you have a big overdraft and owe thousands of pounds on high-charging credit and store cards? If so, you would almost certainly be better off using the money to clear the debts.
With cheaper debts, such as mortgage loans, there is also a strong case for paying off capital. The main rule of thumb to consider is whether the cost of borrowing is more or less than the return you could get by investing the money. Let's say you are paying a standard variable mortgage rate of 8.7 per cent. The true rate would be slightly less than that on the first pounds 30,000 loan, assuming you get mortgage tax relief (Miras), but still around 8 per cent. Can you get more than that after tax from investing the money? The best tax-free Tessas are paying less than 8 per cent. Tax-free stock market investment through a PEP might be more promising. Index tracker funds, for example, had a very good year in 1997, but that is unlikely to be repeated year on year. You'll have to decide whether the risk is worth taking.
It is also important to check with your lender whether there will be any penalties for a partial repayment. There may well be a penalty if you have recently enjoyed a discounted rate. Discuss your plans with your lender. Find out, too, whether your repayment will have an immediate effect on the interest you are charged, or whether you would be better off making the payment nearer the lender's financial year-end. You'll also have to make clear whether you want to shorten the term of your loan, or keep the same term and benefit immediately by having a lower monthly payment. Don't pay off your mortgage if you are likely to want to borrow at a more expensive rate (for example, to buy a car) in the foreseeable future.
I have two fixed-rate mortgages, one on my main residence for pounds 32,000 and one on my holiday home for pounds 33,000. Crunch time comes at the end of February when both loans revert to the standard variable rates. For a period of three years I will have to put up with these rates or pay a six-month interest penalty if I switch to a different lender. Is there anything I can do?
CM, West Yorkshire
You have a legally enforceable agreement which obliges you to pay a six-month interest charge if you pay off your mortgage in the next three years. There is no way round this. You need to find out whether another lender can offer you a lower rate which, over time, will more than make up for the cost of switching lenders.
There are usually costs for anyone switching lenders - arrangement fees, valuation fees, legal fees and so on (although some lenders agree to pay some of these). If you have an interest penalty to pay, this is simply an extra switching cost. You'll also need to take account of the cost of any compulsory insurances you have with your current lender. In truth, the costs of switching lenders are often high enough to make switching uneconomic.
Take a current two-year fixed rate of 4.99 per cent from the Woolwich. Compared with a typical variable rate of 8.7 per cent, that's a potential saving of 3.71 per cent a year (3.34 per cent on the first pounds 30,000 of a loan including Miras tax relief). Over two years you could have a saving of pounds 2,002 on a pounds 30,000 loan, or pounds 4,230 on a pounds 60,000 loan. The saving would rise if variable rates rose further. But, equally, it would fall if variable rates were to fall.
Against this potential saving you would need to deduct the Woolwich's fee of pounds 295 and the possible extra cost of Woolwich's buildings and contents insurance, compulsory in the first year. You would then need to deduct the legal costs, valuation costs and any other unavoidable costs. Deduct, too, your interest rate penalty - pounds 1,175 on a pounds 30,000 loan and pounds 2,480 on a pounds 60,000 loan. Another possible hidden cost is that your current lenders are both mutuals. They could convert to banks and produce windfall shares for borrowers. The Woolwich has already converted and so will not be giving away any more windfalls.
All in all, switching may not be a worthwhile option. Your best hope may lie in the expected, possibly dramatic, fall in mortgage rates. Short- term interest rates have been rising but medium-term rates have been falling. We could be in for an era of low mortgage rates, but rates may not begin to fall until 1999.
My 59-year-old husband had to give up work two years ago because of ill health. He receives pounds 1,000 a month from a permanent health insurance (PHI) policy until his 60th birthday. He also has four different pension plans. Will he be allowed to withdraw tax-free lump sums from these plans while putting off buying an annuity?
CK, West Sussex
New rules have been in place since 6 April, 1995. They allow you, within limits, to draw an income from a pension fund while postponing buying a pension annuity. You can delay the pension annuity until the age of 75 at the latest. At this age you will obliged to buy an annuity in the normal way.
Roughly speaking, you can take a quarter of your fund as a tax-free lump sum. The proportion will be less than this if you intend to provide a dependent's pension. The same applies if your fund has received rebates of national insurance because you have contracted out of the state Serps pension. The Serps replacement element cannot be taken as a lump sum.
If you opt to withdraw an income and delay the annuity you can also decide at the point you start drawing the income to take your tax-free lump sum. The possible benefit of having this more flexible way of using a pension fund, however, comes at a price because of extra administrative costs. Your income withdrawals have to be monitored to make sure they fall within the prescribed limits. The option may not be cost-effective for pension funds of less than pounds 100,000.
q Write to Steve Lodge, personal finance editor, Independent on Sunday, 1 Canada Square, Canary Wharf, London E14 5DL, and include a phone number, or fax 0171-293 2096, or e-mail firstname.lastname@example.org. Do not enclose SAEs or any documents you wish returned. We cannot give personal replies orguarantee to answer letters. We accept no legal responsibility for advice given.
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