Personal finance: A good home for spare cash

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The Independent Online
If you have a few hundred pounds to spare, now is the time of year to consider cutting the size of your mortgage loan. But, as Paul Slade reports, you must act quickly in order not to fall foul of the lenders' rules.

With many mortgage lenders charging interest of up to 8.7 per cent, while all but a few savings accounts pay little more than 6 per cent, cutting your debt can make more sense than topping up your savings.

In fact, the advantages of paying off your loan can be even greater. If you are a basic-rate taxpayer, the effect of repaying a mortgage is to enhance the value of the capital you have paid off by 23 per cent, giving a gross return of 10.7 per cent, assuming a mortgage rate of 8.7 per cent. For higher-rate taxpayers, the uplift is equivalent to a gross return of about 12.18 per cent on the same mortgage.

One way of repaying the loan is to use any spare cash to reduce the outstanding capital sum on your mortgage, by paying in a lump sum over and above your regular monthly repayments. The rate of interest you pay remains unchanged but, because that rate is being calculated on a smaller debt, your monthly repayments will fall. Alternatively, you can leave your monthly repayments unchanged and close your mortgage early instead.

Philip Cartwright, of London & Country, an independent firm of mortgage advisers, says even overpayments of just a few hundred pounds can be worthwhile. "It all makes a difference," he says. "You're being charged something like 8 per cent on your mortgage, and where are you going to get that sort of return on an investment account?"

Nationwide says a single overpayment of pounds 400 made now on a pounds 70,000, 25- year repayment mortgage, opened five years ago at its current standard variable rate of 8.1 per cent, would produce a total saving of pounds 1,449. Making a pounds 400 overpayment every year from 1997 onwards on the same loan would produce a saving of pounds 9,617 over the full term.

Many lenders will take overpayments of less than pounds 1,000 into account only once a year, often at the end of December. Even then you will need to be very clear that you intend this as a capital repayment, and expect your future payments to be recalculated accordingly.

A spokesman at Nationwide says: "If you want to make a small overpayment, this is a good time to do it. During the year, we would say the best thing to do is stick any spare money into your savings account to earn interest on it, and then pay it into the mortgage as a lump sum towards the end of the year."

Keen investors who are not risk-averse may be better off devoting any spare cash to boosting their PEPs - returns on which could outstrip the mortgage rate - or topping up their pensions. But at London & Country, Mr Cartwright believes this will apply to only a minority of borrowers.

He says: "If you're somebody who would just witter that money away, probably one of the wisest things you could do is pay off part of the mortgage at the end of the year. From a discipline point of view, it's very sensible."

Overpayments need care, however, as each lender has its own rules. Most will accept overpayments of pounds 1,000 or more at any time in the year, adjusting your interest calculation at the beginning of the following month or - if sooner - next time there is a rate change. Check your own lender's policy on overpayments before taking any action.

Even if you are making an overpayment of more than pounds 1,000, it is important to tell your lender in writing that you want this treated as a capital repayment. Get their confirmation in writing too. Mr Cartwright says: "If you just went in and paid pounds 1,000 over the counter to your mortgage account, they would treat it as subscriptions in advance, which is a crafty way of not crediting that interest to you. A lot of people fall foul of that over quite large amounts."

Among the top five lenders, both Abbey National and Nationwide credit small overpayments on 31 December each year, and larger ones from the first of the months following deposit. Halifax credits overpayments of less than pounds 500 each 31 January. Woolwich credits overpayments of less than pounds 500 each 30 September, but larger ones the day after deposit. Cheltenham & Gloucester will credit all overpayments on the first of the following month, but makes a pounds 25 charge for doing so when the sum is less than pounds 1,000.

Another thing to remember with almost all mortgages is that, once your money is paid in, it cannot be taken out again. A handful of new-style flexible loans from Virgin, Legal & General and The Mortgage Trust, which combine the features of a mortgage and a bank account, will let you withdraw any extra money you have built up in the account. But, so far, these products have generally charged higher interest than conventional loans, and lack the fixed-rate or discount offers available in the high street.

Remember also that, if you have a fixed-rate or discount-rate mortgage, there may be penalties for early repayment which remain in force long after the offer period has expired. These will wipe out any benefits of overpayment.

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