Your Money: Cut the mortgage and save a bomb - Time is right to reduce term of home loan and slash the overall interest bill
Sunday 23 October 1994
Average mortgage terms have lengthened in Britain - until recently, 20-year loans were considered the norm. Longer repayment periods make sense when house prices are expensive relative to earnings, and when high inflation is eating quickly into the real value of the loan. But with inflation low and house prices stable at present, it may be time to think again.
'The logical thing now might be for terms to shorten,' said Peter Williams, head of research at the Council of Mortgage Lenders. 'Certainly, people are repaying earlier.'
Vera and Michael Long of Bingley, west Yorkshire, are a good example. They have just come to the end of a two-year fixed mortgage with the Cheltenham & Gloucester and have decided to switch to another fix, this time with Northern Rock. 'We decided to take five years off the mortgage term, reducing it from 17 years to 12 years,' Mrs Long said.
'We're both 48, and we're both hoping to retire when we're about 60. It's a comforting thought that the mortgage will be paid off by then.' Their actual outgoings are likely to remain much the same, since their new fixed-rate mortgage is substantially below the old C&G's rate.
'I have never understood the reason why 25-year mortgages existed. I think people should fit their mortgage term to something they can foresee, so that they arrange to pay it off when they retire or when the kids leave home,' said Clive Miers, chairman of Miers, a mortgage adviser.
His firm has encouraged borrowers to shorten their terms by taking the sometimes substantial initial cash-back or interest discounts offered by many lenders on repayment mortgages but paying the normal payment in the first year. 'This can save the borrower thousands of pounds, by clearing the mortgage several years early. The discount comes straight off the amount of the mortgage outstanding,' Mr Miers said.
The arithmetic can certainly be revealing. A home-owner who borrows pounds 50,000 at 8.1 per cent on a 25-year repayment mortgage, for example, would have paid about pounds 57,000 extra in interest by the time the loan was repaid. Take the same loan over 20 years, and the total bill for interest falls to about pounds 44,000. The monthly payment for the 20-year mortgage is only about pounds 30 more - pounds 387 as opposed to pounds 353. (These figures are based on continuing 20 per cent tax relief, so in reality underestimate the actual payments).
The shape of the repayments curve means, in fact, that the longer the mortgage term is extended, the smaller the savings on monthly payments become. 'Once you go above about 20 years, it has very little effect on reducing payments - you just pay more interest,' said Mr Williams.
Britain's largest lender, the Halifax Building Society, says it is happy to consider requests for loans over any length below the standard 25 years.
However, a spokesman admitted that the vast majority of its borrowers with repayment mortgages automatically topped up their mortgage back to 25 years each time they moved house.
'It's worth asking: 'Can I afford, say, a 20-year mortgage?' You can benefit from thousands of pounds if you do that,' he said.
Paradoxically, Mr Miers believes that the recent rise in interest rates may encourage borrowers to reduce their mortgages more quickly - to get rid of debt - even if this means higher payments.
A number of specialist companies are now offering 'mortgage acceleration' advice on how to pay off mortgages faster and the idea may spread. 'Mortgage acceleration is a little-known subject in the UK, but in Canada, the States and Australia it's big business. Something like 60-70 per cent of mortgages in Australia have facilities for making early payments,' says Richard Lacy, chief executive of the Independent Mortgages Corporation.
But the process is relatively easy to undertake on a DIY basis. If you have an endowment- linked mortgage, one possibility is to maintain the policy to its original maturity date while paying a lump sum as capital repayment to the lender. Interest payments will continue for the full term, but at a reduced level, and more of the endowment proceeds will ultimately be yours to enjoy.
Mr Miers said a preferable route was to negotiate with the insurer to reduce the length of the endowment policy.
'All the major companies will do this, although arranging it can be a hassle,' he said. The eventual payout will be reduced to allow for the shorter contribution and investment period. (Tax rules mean that endowments must run for at least 10 years.) There may be other penalties, although these should be minor. Standard Life, for example, says it makes a pounds 40 charge for altering the term of a unit- linked policy. There is no charge for changing with-profits endowments.
Repayment mortgages are generally more straightforward. Most building societies recalculate their borrowers' accounts once a year, when payments over the previous 12 months are allocated initially against interest due; any extra is used to reduce the outstanding balance, on which the next year's interest is calculated.
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