Personal Finance: Pay up and save

New flexible mortgages mean cash up front cuts thousands off your final payment - and a bigger pension, says Teresa Hunter
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The Independent Online
The love affair of our life now lasts just nine years and 10 months according to the latest statistics on UK marriage, yet mortgage lenders still expect us to plight our troth for a quarter of a century. In a world where everything, not least relationships and careers, has a shelf-life, the traditional 25-year-mortgage is long past its sell-by date.

Britain's second biggest mortgage lender, the Abbey National, this week crossed the Rubicon and accepted that borrowers are no longer prepared to suffocate under a mountain of mortgage debt through their working lives. It has joined the growing band of lenders to launch a flexible homeloan, allowing them to pay their debts early and slash thousands off the final cost of their property. The new flexible mortgage is available initially only to existing borrowers.

Ambrose McGinn, the Abbey's product director says: "Customers sent us a message we could no longer ignore. Their working lives have changed. They want more flexibility on mortgage repayments. We expect a significant portion of customers to switch."

Buying a home with a traditional 25-year mortgage used to be about as close as you could get to winning the lottery without risking a stake. During the two previous inflation-ridden decades, you bought a house, the price soared, and the cost of the repayments plummeted.

The longer you delayed settling the debt, the less you paid in real terms. Tax relief cut interest charges by at least a third and inflation did the rest. In six years your mortgage payments effectively halved in value. Today borrowers face much harsher economic conditions. Tax relief has nearly disappeared and we would have to wait 26 years for inflation to erode our monthly outgoings in the same way. There's no funny money to come to the rescue any more. We repay our debts with hard-earned cash.

With no jobs for life, most of us will be down on our luck at some stage. Even those who enjoy steady work may want to retire early. Who will pay for it all, when it's clear the state pension will not?

This is the backcloth which makes switching to a flexible mortgage the smartest move a homebuyer can make. They allow you to overpay in good times, and borrow back in bad because they have a different way of calculating interest which takes extra payments into play the moment they hit the account. For most people this means they are always cheaper.

With a traditional mortgage, interest is calculated once a year, so extra payments don't win you any Brownie points at all. Most lenders will recalculate on request if you make a significant one-off overpayment, but regular small savings have no impact.

Flexible mortgages calculate interest either daily or monthly, so money credited on your homeloan account will cut your interest bill. It makes a nonsense paying 6.85 per cent while excess funds are lying around earning 0.4 per cent in the bank. But that is precisely what millions of homeowners are doing. With a flexible account you slice your ultimate costs by exploiting those excess funds to the full. Virgin's flexible mortgage takes this proposition to its ultimate degree by allowing you to pay in your salary each month, and actually use the running balance that provides to cut the bill.

Virgin estimates that without overpaying a penny, a typical pounds 80,000 borrower earning pounds 45,000 would save pounds 4,560 interest and reduce the term by 38 months. Sounds tempting? Wait until you hear the bottom line. By stopping the mortgage early a borrower will save nearly pounds 20,000.

The Abbey is proceeding cautiously. The new account is technically known as a hybrid base rate-tracker, with a flexible loan. It will be available at first only to existing customers with a proven track record, and is less competitive than some on the market.

If you want a base rate tracker, Leeds & Holbeck is charging base rate if you buy their insurance, or a 0.24 per cent loading over base, giving a 5.24 per cent charge for those not buying the insurance package. The Abbey tracker will load base rate by 1.3 per cent.

But there are still huge savings to be made if you have a repayment rather than an endowment mortgage. Roughly, an pounds 80,000 borrower can cut the interest payments by a third by overpaying his pounds 520.72 monthly repayment by just pounds 100. But he could pocket nearly pounds 47,000 more by settling the debt early. Now that's a nice lump towards a pension.

Pay pounds 400 extra monthly and you pay just pounds 26,000 in interest over nine and a half years, giving you nearly pounds 60,000 towards your pension. This compares with pounds 83,000 in total interest at today's rates if you had stuck with the standard Abbey loan.

The mortgage is available only on loans of less than 75 per cent of the value of the property, and loans above pounds 40,000. But although its flexibility leaves something to be desired, it's not as restrictive as some.

The Coventry's table-topping flexible mortgage, for example, allows borrowers to repay early, but continues to calculate interest annually. Others such as the Yorkshire Bank or Mortgage Express also offer limited flexibility.

Mr McGinn sees this launch as a learning process. He says: "We want to monitor how our customers, who we already know can manage their money wisely, will use the account. We expect significant interest, and given the size of our loan book we could not afford to rush in. When we've accumulated more information we will expand and offer different features."

To be fair to mainstream lenders who resist flexible loans because of the huge cost in lost interest, the new entrants with bargain deals may not always look so chirpy. Virgin Direct has suffered a pounds 13m loss, the Pru admits Egg cost pounds 100m, and Standard Life has poured pounds 15m down the bottomless pit of its bank.

For flexible mortgages to work, they have to be viable for the customer and the bank, which is why the Abbey's move is so significant. Its package will be around, when the new players are off in pursuit of yet more pastures new.