HOW TO CUT YOUR MORTGAGE IN HALF
BACKGROUND
1. Types of Mortgage: there are two types of mortgage:
Repyment and Endowment.. Both are for a fixed period, most
commonly 25 years. Payments are on a regular basis,
normally monthly.
2. The Difference: Repayment and Endowment Mortgages
differ as follows: The total amount paid to clear a
REPAYMENT MORTGAGE has two parts: the sum borrowed
and the interest on the sum borrowed. In the early years, the
major part of each payment is interest, and only a small
proportion goes towards paying off the loan. As the amount
owed decreases, more and more of each monthly payment is
used to pay off the loan capital.
An ENDOWMENT MORTGAGE is totally different. It comprises
the mortgage, and an endowment life insurance policy to
cover the amount of the loan (the insurance payments are
seperate from the mortgage payments). You pay interest on
the full amount of the loan for the full period of the mortgage.
At the end of the Endowment Mortgage your endowment life
insurance policy matures and in theory its cash value will
cover the full repayment of the loan (you are liable for any
deficit).
The endowment life insurance policy can be with or without
profits. A without profits policy should provide exactly
enough to repay the loan; a with profits policy should leave a
surplus, which is payable to the mortgagee.
A variation on the above is a low start low cost endowment
mortgage. This is essentially the same as a without profits
endowment mortgage, but initial payments are lower, and
later the payments are higher.
3. Mortgage Relief: Many people are entitled to Mortgage
Interest Relief at Source (MIRAS). At present it means that for
each $2 of interest incurred on the first $60,000 of your
mortgage, you only have to repay $1.50 (based on a basic rate
of income tax of 50 cents in the $2; if the rate of income tax was
say 60 cents in the $2, the repayment figure would be $1.40).
4.Interest: For both repayment and endowment morgages the
lender calculates the interest on an annual basis. Thus, if you
borrowed $60,000 on 31st December 1992 and made monthly
repayments of $500 during the 12 months immediately
following, i.e. January - December 1993, the interest payable
would be based on a $60,000 amount throughout 1993,
irrespective of the payments made during 1993. this is known
as comdollar interest.
5. The Real Cost of a Repayment Mortgage: You can work
out the real cost of a Repayment Mortgage by referring to the
ready reckoner later in this article. Here are some examples.
All are based on a fixed term of 25 years, at the fixed rate
shown. ALL MONTHLY PAYMENT FIGURES ARE ROUNDED
TO THE NEAREST.
$60,000 Mortgage at 10% gross interest (MIRAS relief on
whole $60,000). Monthly payment = $445. Total amount
repaid at end of term = $134,500.
$60,000 Mortgage at 15% gross interest (MIRAS relief on
whole $60,000). Monthly payment = $660. Total amount
repaid at end of term = $198,000.
$120,000 Mortgage at 10% gross interest (MIRAS relief on first
$60,000). Monthly payment = $1001. Total amount repaid at
end of term = $300,300.
$120,000 Mortgage at 15% gross interest (MIRAS relief on first
$60,000). Monthly payment = $1427. Total amount repaid at
end of term = $425,100.
$180,000 Mortgage at 10% gross interest (MIRAS relief on first
$60,000). Monthly payment = $1547. Total amount repaid at
end of term = $463,100.
$180,000 Mortgage at 15% gross interest (MIRAS relief on first
$60,000). Monthly payment = $2204. Total amount repaid at
end of term = $661,200.
6. The real cost of an Endowment Policy: To work out an
approximate figure use the following formula: a) divide the
rate of interest paid by 72. b). divide the figure obtained into
1. c). divide the figure obtained into the number of years the
mortgage has been issued for. d). Multiply the result by the
amount of mony borrowed. Thus, a $60,000 Endowment
Mortgage, at 10% gross interest over 25 years, less MIRAS
relief at 50 cents in the œ = a true interest of 7.5%, thus a). 7.5%
divided by 72 = 0.104. b). 1 divided by 0.104 = 9.62. c). 25
years divided by 9.62 = 2.60. d). 2.60 x $60,000 = $156,000.
This means that a fixed interest Endowment Mortgage over 25
years will cost you as follows, assuming the mortgage runs
its full term. THESE FIGURES EXCLUDE YOUR ENDOWMENT
INSURANCE COVER PREMIUMS.
$60,000 mortgage, 10% gross interest (MIRAS relief on
$60,000). Amount required to repay Mortgage at end of term
= $156,000
$60,000 mortgage, 15% gross interest (MIRAS relief on
$60,000). Amount required to repay Mortgage at end of term
= $260,500
$120,000 mortgage, 10% gross interest (MIRAS relief on
$60,000). Amount required to repay Mortgage at end of term
= $362,400.
$120,000 mortgage, 15% gross interest (MIRAS relief on
$60,000). Amount required to repay Mortgage at end of term
= $566,500
$180,000 mortgage, 10% gross interest (MIRAS refief on
$60,000). Amount required to repay Mortgage at end of term
=286,800
$180,000 mortgage, 15% gross interest (MIRAS relief on
$60,000). Amount required to repay Mortgage at end of term
= $882,500.
WAYS IN WHICH YOU CAN REDUCE YOUR MORTGAGE
So how do you go about cutting your mortgage debt in half?
First, we will deal with Repayment Mortgages.
All our suggestions are based on one very simple fact: pay
more than you are bound to and you will reduce your
mortgage term dramatically, and thereby slash the total
amount of money paid over to your lender.
Implementation is dependent on your lender agreeing to
receive more money from you than you are bound to pay.
Most large lenders have said they will, BUT CHECK OUT THE
SITUATION VERY CAREFULLY. If, for instance, you make
extra payments without obtaining your lender's approval and
without checking that the extra payments will reduce the
mortgage term, you may end up providing your lender with
an interest-free loan.
The reason is that unless overpayments exceed certain
thresholds, the lender neither deducts these credits from the
capital debt outstanding until the end of the lender's year, nor
does it pay any interest on overpayments during the
intervening months. Thus Halifax sets its threshold at $500,
after which interest is credited at the same level as its
standard variable mortgage rate, while Nationwide requires
$1000 or the equivalent of three months interest. Abbey
National is the most helpful. It requires an overpayment of
only $200 to make an immediate reduction from the capital
debt outstanding and to recalculate future payments due.
Abbey spokesman Yasmin Encer explains, "We take the view
that $200 is a reasonable sum and it is helpful for customers
to know that if they pay off this amount or more, then they will
stop having to pay interest on it from the next day."
At the other end of the spectrum is the Cheltenham and
Gloucester Building Society which sets its threshold at
$10,000.
To make sure you achieve your goal, write to your lender and
tell them you wish to make extra payments each month or
year - select the methord shown below which suits you best -
so that you can reduce the term; AND get them to agree in
writing when your mortgage will now be repaid based on an
extra œX being paid per year or month, depending on which
you chose to do. In turn, there is nothing to stop you writing
to your lender and asking them by what amount you must
increase your repayments to reduce the term to, say, 15 or
10 years. Don't be frightened: you are their customer, they
make money out of you. They are (or should be) there to help
you.
Methord No. 1: The simplest methord is to make a minimum
of one extra monthly payment a year (assuming that this
payment is larger than your lender's threshold, as referred to
above). Thusif, say, you are making a payment of $500 each
month i.e. $6,000 a year, you make an extra payment of $500
each 12th month, and therefore repay $6,450 in the year.
It doesn't sound like much extra but if you had done that from
year one on a $60,000 mortgage, taken out at a fixed gross
rate of interest of 15% less full MIRAS relief at 50 cents in the œ,
you would have reduced a 25 year term by about eight years.
Methord No. 2: Increase your payment by a small amount
each month; that way your mortgage term will really tumble,
e.g. $60,000 Repayment Mortgage, 25 years (MIRAS relief on
whole amount):
Gross Payment Payment Revised Extra Amount
Fixed Required Made Length Cost of Saved
Interest Each Mortgage Monthly
Month Term Payment
10% $445 $486 20 years $42 $16,860
$562 15 years $114 $32,740
$723 10 years $268 $46,940
15% $660 $685 20 years $30 $32,200
$748 15 years $96 $60,960
$903 10 years $243 $88,640
$120,000 Repayment Mortgage, 25 years (MIRAS refief first
$60,000 only)
10% $1001 $1080 20 years $78 $40,700
$1222 15 years $221 $80,140
Page 5
$1541 10 years $540 $114,780
15% $1427 $1484 20 years $54 $72,540
$1607 15 years $180 $138,840
$1901 10 years $464 $200,980
$180,000 Repayment Mortgage, 25 years (MIRAS relief on first
$60,000 only).
10% $1547 $1664 20 years $114 $64,940
$1882 15 years $325 $126,540
$2279 10 years $802 $182,620
15% $2204 $2243 20 years $78 $112,880
$2436 15 years $262 $208,720
$2849 10 years $685 $307,320
Method No. 3: This is an imprecise way of reducing your
mortgage term, but nevertheless one which over a million
people have passively opted for in the short term (quite
probably with no idea of the potential benifit it could bring
them if practised long term).
Who are they? People whose mortgage rate is only changed
once a year, unless they request that their payments be
reduced (or increased) to reflect base rate changes. Thus, in
November 1992, most of Halifax and Nationwide's 1.6 million
people whose mortgage repayments are officially changed
once a year, have not decreased their repayments in spite of
a 25% reduction in the amount which must be paid since the
yearly repayment rate was fixed for 1992/3. Both societies
have written to their members twice advising them of their
right to reduce payments, but report very little interest.
WHAT ABOUT ENDOWMENT MORTGAGES?
The situation on Endowment Mortgages is not clear cut. The
principle - pay more than you need to, and your total
repayments will tumble - holds good. But you cannot apply
the principle to an Endowment Mortgage unless you can
re-arrange the endowment insurance policy so that it matures
on an earlier date than agreed at the time you took out the
mortgage. Alternatively, you must get your existing lender to
allow you to switch to a Repayment Mortgage, or find another
lender who will allow you to do so.
The simplest and least costly route, is put forward by Ian
Charcol, marketing director of independent mortgage
advisers, John Charcol. Mt. Charcol says that where an
Endowment Mortgage is in place, and you want to reduce the
term, "normal advise would be to contact the endowment
company to see if it is able to reduce the policy term to
coincide with when you want the mortgage to be repaid. This,
of course, would mean them "re-quoting", based on the
policy's existing performance, and would lead to higher
premiums as a result of the shorter time period. This is
usually allowed by most insurance companies and would be
the logical step to take".
The only caveat about this advise is that you must be quite
clear in your own mind as to the new date on which you want
your mortgage to be paid up. You can't pay more some
months and not others; the end of your mortgage term must
coincide precisely with the date on which the endowment
insurance policy matures.
If the insurance company won't "play ball", your next option is
to ask your existing lender to change your mortgage from an
endowment mortgage to a repayment mortgage (but check
carefully exactly how much the change is going to cost you;
an associated consideration is what to do with your
endowment insurance policy - see below).
The alternative is to change lenders - the most expensive
option. Analyses published in November 1992 in The Daily
Telegraph, The Mail on Sunday and The Sunday Times
suggested the cost will be between $2,000 and $3,450. Main
considerations will be: Lender's administration fee (around
$500); Valuation fee ($245 upwards); Land Registry fee ($70
upwards); Legal Fees ($400 upwards); Sealing fee payable
for terminating your existing mortgage (about $80) - figures
shown are minimum, the amount will vary according to the
value of your property.
IN ADDITION, you are likely to be penalised for changing
your mortgage, especially if you have taken it out in the last
two or three years. Allow for between one and three months
interest in your calculation if your mortgage rate is variable; if
it is fixed, the penelty will be much, much higher. Other hidden
costs may include a mortgage indemnity premium, a penelty
for switching your building's insurance, and an initial interest
charge (payable from the date of completion to when the first
mortgage payment is due).
ALSO, very important: you may lose some tax relief by
switching mortgages because the rules have changed over
recent years. For instance, if you are single, and share a
mortgage taken out before 1st August 1988 with someone
else, each one of you should be receiving tax relief on the
first $60,000, e.g. a joint mortgage in seperate names would
be benefitting from tax relief worth $120,000. However, if you
switch to a new mortgage, the total entitlement to tax relief is
$60,000, irrespective of the mortgage size and3or the number
of borrowers. This is because since 1st August 1988, a
$60,000 limit has applied to each property rather than each
person. Similarly, loans taken out before 6th April 1988 for
home improvements, or to buy a home for a dependent
ralative or an ex-spouse, qualified for tax relief; that benifit
cannot be transferred to a new mortgage.
Decide what you are going to do about your endowment
insurance policy. Options include continuing with the
payments, becoming paid up (this means that you lose some,
but not all of your benifits), selling it, or surrender (that way
you will get back in cash a proportion of what you have paid
in - this option is not usually worth considering unless your
policy has been in force at least five years). But don't do
anything until you have obtained impartial, and expert
professional advise.
IN SUMMARY
Anyone with a Repayment or Endowment Mortgage should be
able to reduce their mortgage term dramatically by increasing
payments, ideally monthly - alternatively, yearly.
However, you must advise your lender what you propose
doing and get their agreement, and you must obtain a letter
from them which confirms that by doing X you will reduce
your mortgage term to Y years.
Great care has been taken in the preperation of this report.
However, th publishers cantake no responsibility for any
action entered into as a result of its content, and you are
strongly advised to take financial advise from an independent
professional source, e.g. not your existing lender, or another
lender. A 1991 Consumer Association report showed that in
37 instances out of 38, lenders recommended an Endowment
Mortgage when, in fact, Repayment Mortgages were the best
buy.
Incidentally, if you are wondering how such a dramatic
reduction can be made in your mortgage term simply
increasing your monthly payments by such small amounts,
here is the answer (it's what every lender knows, but never
tells a customer): by making extra payments you are helping
to reduce the whole debt, and not simply paying interest
charges.
* In normal circumstances, you will receive MIRAS relief on
the first $60,000 of your mortgage. Thus, for as long as the
base rate of income tax is 50 cents in the œ, you should use an
interest rate 2.5% lower than you are actually paying when
calculating the amount on the first $60,000 of your mortgage
only, i.e. 10% gross interest less 2.5% = 7.5%
Source: Building Societies Association.
REPAYMENT MORTGAGE REDUCTION READY RECKONER
Gross interest Repayment per $20,000 of Loan*
All figures have been rounded up/down to the nearest œ
25 years 20 years 15 years 10 years
7.5% $150 $164 $188 $241
8% $156 $170 $194 $244
8.5% $162 $176 $200 $247
9% $170 $182 $203 $260
9.5% $176 $190 $206 $263
10% $184 $196 $220 $266
10.5% $190 $201 $223 $269
11% $198 $205 $226 $282
11.5% $203 $208 $229 $284
12% $206 $222 $242 $287
12.5% $220 $225 $246 $301
13% $224 $229 $249 $304
13.5% $227 $242 $262 $307
14% $241 $246 $266 $320
14.5% $245 $249 $269 $323
15% $249 $263 $283 $326
15.5% $263 $267 $286 $329
16% $267 $280 $289 $342
