Wealth Check: Flat broke - 'My home is eating up my cash'

How can a teacher build proper savings for the future when there's so little left after the monthly mortgage payments? Interview by Harriet Meyer
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The patient

Damian King, 29, wants to stop the monthly repayments on his home loan swallowing up such a hefty proportion of his money. He earns £45,000 as head of science at Brighton College, East Sussex. Yet despite this decent salary, he finds it tricky to live within his means after paying £1,150 a month – or more than half his disposable income – for a £160,000, 25-year repayment mortgage with Cheltenham & Gloucester, which is on a fixed rate of 6.5 per cent for three years.

"I wonder whether it's worth increasing the term of the mortgage, or switching to interest-only to cut my repayments," he says. "All my outgoings are crucial, but the size of my home loan means I can barely afford to save anything."

He also pays management fees of £1,500 a year on his one-bed leasehold flat on Brighton's Marina, bought for £180,000 in June 2006.

While he hopes his home is now worth around the same sum despite the property slump, this is a worry. "I reckon I might be piling money into a big hole," he explains.

Despite not making regular savings, Damian has managed to amass around £1,500 in a cash individual savings account (ISA) with HSBC, which pays 3.2 per cent. He also holds £1,000 in Premium Bonds.

The only other debt he is servicing is £12,000 in student loans from his time studying physics at Oxford. He does not have any credit cards.

"I am careful with my money, although I am concerned about my small savings for a rainy day," he says. "But I think that putting money into the mortgage is probably a better bet, with interest rates as low as they are."

He is a keen sailor, and also pays £150 a month towards the upkeep of a family racing yacht. "One day I hope to be able to afford a boat of my own, though this is some way off. It is a long-term goal."

As regards retirement planning, Damian has been paying 6 per cent of his salary for the past seven years into the Teachers' Pension Scheme , which is a final-salary arrangement. "Perhaps I should be paying into an extra pension scheme, but I just don't have the spare cash," he says.

At the moment, he has no protection policies in place.

The cure

Damian faces the classic choice. "He either needs to earn more or spend less," explains Gordon Bowden from independent financial adviser (IFA) Quainton Hills Financial Planning.

Yet with a relatively secure job as Britain sinks into recession, he is fortunate to be in the sort of stable position from which he can consider his financial situation and increase his disposable income.

Property

A series of cuts in the Bank of England base rate, down to a historic low of 1.5 per cent, means that Damian's 6.5 per cent mortgage deal is uncompetitive. "However, switching to another rate is likely to be impossible," says Mr Bowden.

Banks and building societies have become much more risk averse. "All the best deals are now reserved for mortgages of around 75 per cent, or even 60 per cent, of the property's value," says Geoff Penrice from IFA Bates Investment Services. "And as Damian has a far higher loan-to-value of around 90 per cent, he may not find any deals available to him."

Even if he were able to change rate, he would suffer a penalty for redeeming his current mortgage within the fixed-rate period, in addition to remortgaging fees, adds Mr Bowden.

So the first step should be to call his lender to see if it can offer a way of reducing the repayments, if he is determined to do so. As Damian is aware, the possibilities include increasing the mortgage term or converting to interest-only. Both options would decrease his monthly repayments, yet they may also store up future financial problems, warn the advisers.

If he moved to interest-only, he would need a strategy for repaying capital at the end of the mortgage term. "And this option has left many borrowers struggling to remortgage to another deal with insufficient equity in their properties," warns Mel Kenny from IFA Radcliffe & Newlands.

Alternatively, increasing the mortgage term may cut the outgoings for now, but only it will also stretch the interest payments over a longer period.

Savings

Damian should ask himself if he wants to save "for the sake of savings", or whether there is a particular goal that he wishes to achieve, says Mr Kenny.

A wise priority is to focus on clearing his mortgage as soon as possible, rather than worry too much about saving, he adds. The interest on the home loan will be greater than any he can achieve on a savings account – particularly given the current paltry rates.

If he is set on building up his savings for an "emergency fund", slotting away up to £3,600 a year in a cash ISA is a good start, and ideally he should have around three months' salary set aside. As interest on these accounts is paid free of tax, they are efficient for a higher-rate taxpayer like Damian. For example, Standard Life's instant access ISA currently pays 3.85 per cent.

One strategy could be to accumulate cash in ISA accounts over the next three years, and use this to repay part of his mortgage when the rate expires. Alternatively, he may want to put the money towards moving up the property ladder. "Either way, building a cash buffer provides security and broadens his options for future financial planning," adds Mr Bowden.

However, Damian should also review the case for keeping his Premium Bonds, Mr Bowden continues. "We all wish we could win a top prize, and these are paid free of tax, but the chances are very small – particularly without holding a large sum." He could cash in his holding and put the money in an ISA, or towards paying off his mortgage.

The advisers suggest various methods for increasing his income. These include doing some extra teaching work, or even turning his living room into a second bedroom. "He may not want to do so, but up to £4,250 a year can be earned tax-free under the rent-a-room scheme," Mr Kenny points out.

Debt

The rate of interest on student loans is very low – currently around 3 per cent – making it a particularly cheap debt. But Mr Kenny points out that many savings rates are around this level now, so the tactic used in the past of putting spare cash into a savings account rather than paying down a loan no longer holds water.

But making overpayments is not a priority for Damian. He should continue paying this debt off gradually.

Retirement

Damian is fortunate to belong to one of the last remaining final-salary pension schemes, and there are several ways in which he could top up his contributions in the future.

The Teachers' Pension Scheme offers the chance to buy added years through additional voluntary contributions (AVCs), which are guaranteed to provide extra income in retirement. "This can be extremely valuable and does not involve investment risk," says Mr Bowden.

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