The redeeming features of early repayment

One of the best homes for windfalls is clearing a loan, says Richard Miles
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The Independent Online
PAYING off your mortgage early is nearly always a good idea, according to independent financial adviser and mortgage broker, Chase de Vere.

David Duncan, a director of the firm, recommends that borrowers who receive a cash windfall should first consider their income needs, then use the remaining money to pay off their mortgage. He says: "You should pay off any outstanding debts, such as credit-card bills or bank loans, put aside some money as a nest-egg, and if there's any left, redeem your mortgage as soon as possible."

Even with tax relief (Miras) at 15 per cent on the first pounds 30,000 of any mortgage, Mr Duncan maintains it is better to repay the loan early in the vast majority of cases. The saving in interest payments can be enormous - up to pounds 50,000 on a pounds 60,000 interest-only, 25-year mortgage.

With standard mortgage interest rates at 7.49 per cent, Miras reduces the mortgage rate on the first pounds 30,000 of the mortgage to 6.36 per cent. Borrowers with mortgages of pounds 30,000 or less who are earning less than 6.36 per cent net on savings would be better off using the money to reduce their loan. Borrowers with loans of more than pounds 30,000 need to earn that much more.

You do not have to land a windfall to repay your mortgageearly. Simply by increasing your monthly premium, you can shorten the term of your loan and save thousands of pounds in interest payments.

Most lenders will allow you to overpay each month, but the majority do not credit the money to your mortgage account until the end of their financial year. If this is your lender's practice, it is more profitable to save the money in an interest-bearing deposit account and hand it over to the lender just before the year end. One-off lump sum repayments, usually pounds 200 or more, can usually be credited sooner.

Your lender may also charge a fee for the administration of overpayments - so check first to see if it is actually worthwhile.

Some lenders now sell mortgages that are specifically designed to allow borrowers to vary the level of their monthly payment at no extra cost. Legal & General's Flexible Reserve Mortgage lets borrowers make additional payments each year. In effect, your money goes into a savings account that you can use to build up a cash reserve or to pay off the interest on your mortgage each month. Borrowers can overpay through a lump sum of pounds 500 or more, or by increasing the monthly premium by at least pounds 50.

Centrebank, the Bank of Scotland's lending subsidiary, offers a similar scheme. Its Personal Choice plan allows borrowers to overpay by an unlimited amount each year, and the money is credited to the mortgage account at the end of each month.

Not all lenders are so understanding. Borrowers with fixed-rate or cash- back loans should beware redemption penalties. These may be applied if you redeem all or part of the loan within the first five years. Typically lenders levy penalties of six months' gross interest, although some take more. The Halifax Building Society imposes one of the stiffest penalties, demanding 5 per cent of the advanced loan for redemption within the first five years of a fixed-rate or special terms loan - equivalent to pounds 3,000 on a pounds 60,000 loan.

Northern Rock also insists on 5 per cent of the sum repaid on virtually all mortgages, standard variable and fixed-rate alike. Last year, the society also introduced an additional penalty of two months' gross interest for special or discounted rate borrowers who redeem their loans within seven years.

If you have paid your mortgage for five years or more, the chances are that you will have exceeded the penalty period. But it is vital to check the terms of your mortgage before you plan any changes to your borrowings.

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