Wealth Check: How do I make the most of my mortgage cuts?

A marketing consultant wants to take advantage of rock-bottom interest rates but isn't sure which way to turn. Harriet Meyer has some suggestions


The patient


Nadia Kassas, 27, hopes to make savings on her monthly bills after taking out a base rate tracker mortgage and benefiting from a series of dramatic interest rate cuts.

She has seen her monthly repayments sink from £900 since getting hold of the first rung of the property ladder 17 months ago to just £200 today on a deal that gives a current pay rate of 1.49 per cent. It is pegged at 0.99 per cent above base rate.

"The cuts have been great news and I'm relieved I opted for a tracker mortgage with interest rates so incredibly low," says Nadia, a marketing consultant from Altrincham, Cheshire, who is on a salary of around £25,000. "I just don't know the best way to use this extra money wisely."

As she has an interest-only mortgage of £160,000 with Bank of Ireland, she has yet to start chipping away at the balance of her home loan. "And I would like to start cutting down the loan so perhaps I should put my savings towards reducing it by paying off a lump sum," she says.

However, her current mortgage rate ends in September this year, when she fears her repayments will soar and she will be unable to get another 100 per cent loan-to-value deal.

Nadia originally bought her two-bed flat for £162,000 in December 2007. "I haven't had it valued since then, but I've made lots of improvements to the property such as a new bathroom," she says.

At present, she has some short-term savings, with £5,000 in a cash individual savings account (ISA) with Britannia building society, currently paying 0.8 per cent. She also has £1,000 in National Savings & Investments premium bonds.

Fortunately, she has avoided amassing debt during her twenties. "I try to avoid credit cards," she says, but she still has £7,500 in student loans to repay.

For long-term needs, Nadia paid into a Friends Provident money purchase pension scheme through her previous employer for a year. "I don't know how much is in this fund," she says. "And at the moment I would prefer to invest my money into something I could access.

"I believe in saving for a rainy day, but I don't know if I'll ever seriously invest in a pension."

Finally, for protection purposes, she pays £45 a month for £250,000 worth of life cover with Scottish Provident.

The cure

Fortune has swung in Nadia's favour as the economic crisis has seen a hefty reduction in her mortgage repayments.

Yet she needs to maintain a disciplined approach to financial planning with the climate remaining uncertain, says our panel of independent financial advisers (IFAs).

"Interest rates are unlikely to remain in the doldrums, and Nadia could get a nasty shock when her mortgage deal comes to an end," says Mike Wellby from Honeybee Financial Planners.

Property

When she comes to the end of her deal in September, there is no chance that Nadia could get another product that will lend her 100 per cent of the value of her property. "Lenders remain reluctant to lend more than 85 per cent of a property's value," says Richard Morea from mortgage broker London & Country.

First, she needs to establish how much equity she holds in the property. Although even with the improvements she has made to her home, it is unlikely that its value will have risen at a time when prices are on a downward spiral.

This makes it likely that the best, and only option, for her is to slip on to Bank of Ireland's standard variable rate (SVR), which currently stands at 2.99 per cent. "Nadia is lucky that this rate is so low, but her repayments will still soar when her deal ends," says Mr Morea.

If she continues with an interest-only mortgage, Nadia's repayments will double to around £400. "And if she switched to a repayment mortgage over a term of 23 years, they would rise to about £800," he adds. "This could change as the SVR is a variable rate."

However, if she can afford the repayment option, it will be sensible to start whittling down the capital debt. But she should ensure this will not overstretch her finances, as it could make repayments unsustainable on her current salary.

In the meantime, Nadia should build up her savings to guard against interest rate rises in the future as the economy recovers. At a later stage this pot can be used to pay a lump sum off her mortgage so she can get better deals, and fixed rates to give her secure monthly repayments.

On the plus side, while Nadia may fear that she is in negative equity, her home is a long-term investment, says Neil Mumford from IFA Milestone Wealth Management. "History shows property prices will start to rise again – although we don't know when this is likely to happen."

Savings and debt

Nadia should squirrel away as much as possible into a cash ISA while she can. Despite rates remaining dismal, any savings will put her in a stronger position and give her wider options once the current crisis eases, says Mr Wellby.

Even so, her Britannia account is paying a particularly pitiful rate. She could consider transferring this fund into an Alliance & Leicester Direct ISA paying 2 per cent. "Once she has set savings aside she can tackle paying down her mortgage and retirement planning," says Mr Mumford.

Student debt repayments are made at 9 per cent of earnings over £15,000 a year, and interest is currently charged at just 1.5 per cent a year. It is pegged at one percentage point above the base rate. "Nadia should continue to erode gradually this extremely cheap debt," says Mr Wellby.

Retirement

Providing for a pension is not a priority for Nadia. However, it is worthwhile getting a statement from her previous employer so she can file this for future planning. "At some stage, she should consider joining her company pension scheme – particularly if it will make contributions on her behalf," says Mr Mumford.

As she is still in her twenties, Nadia has decades to make sufficient provision for later life. But she should bear in mind that it is the contributions made in early years that have the most impact, as they have greater chance to grow into a hefty pension fund, the advisers warn.

Protection

Nadia has no need for life cover as a single person, says Mr Wellby. However, she needs some kind of protection to meet her monthly bills if she were unable to work due to long-term illness or disability, and her lender may require that she has this.

An income protection policy is most suitable for her needs. "Although from the size of her monthly premiums, it seems her policy may include other benefits such as income protection or critical illness cover," says Mr Morea.

She should check what is included in her policy, as well as taking into account any cover through her employer. If she is able to do so, switching to another product that covers just her basic income would be a far cheaper option.

Do you need a financial makeover?

Write to Julian Knight at the Independent on Sunday, 2 Derry Street, London W8 5HF

j.knight@independent.co.uk

Independent Partners; request a free guide on NISAs from Hargreaves Lansdown

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