Home ownership freedom: should you try paying off your mortgage early?

Paying off your mortgage early seems like an alluring prospect. But how does it stack up in practice? Paul Thomas explains.

Paying off your mortgage early is an enticing idea. For most homeowners, becoming mortgage-free is the ultimate milestone – and they dream of how to spend the extra cash once their debt is gone.

If you’ve built up a healthy savings pot, it might be tempting to clear your mortgage early and live the rest of your life debt-free. 

But is it always the right move? What should you consider before making that decision? And how do you actually go about it?

Mouthy Money answers those questions – and more – below.

The benefits of paying off your mortgage early

There are plenty of upsides to clearing your mortgage ahead of schedule.

For starters, there’s the peace of mind that comes with knowing your home is fully yours, no matter what life throws at you. If you lose your job or fall ill, you’ll always have a roof over your head.

It also frees up a load of cash that you can put towards other things, such as home improvements, retirement savings or even that holiday you’ve always dreamed of.

Depending on how much you have left on your loan, it could also save you thousands of pounds in interest over the long-term.

For example, let’s say you have a £250,000 mortgage at a 4.5% interest rate over 25 years. That means your monthly repayments would be around £1,390.

If you increase your repayments by just £100 a month (to £1,490) you’d save £21,871 in interest and clear your loan two years and 10 months early.

If you increase your repayments by £200 a month, you’d save £38,458 in interest and shave five years and one month off your mortgage.

Some people prefer to make lump-sum payments, rather than increase their monthly outgoings. But the same principles apply.

Let’s say you received a £10,000 bonus or inheritance and put that money towards the same £250,000 mortgage. In this case, you’d save £19,584 in interest and pay off your loan one year and nine months early.

Great, so I should just go ahead and pay off my loan early?

Not quite. While there are clear advantages to paying off your mortgage, it may not be the best option for everyone.

First, check that your lender allows overpayments and if there are any charges or penalties for doing so.

If you’re on a tracker mortgage linked to Bank of England Base Rate, you can usually overpay as much as you want without charges – but check with your lender first.

However, if you’re locked into a fixed-rate deal, you’ll typically be limited to overpaying 10% of your outstanding balance per year.

So, if you owe £250,000, you can pay off up to £25,000. But if you go over that, you’ll probably have to pay an early repayment charge (ERC) – and they’re not cheap.

On a five-year fixed rate, typically ERCs are 5% of your outstanding balance in year one, 4% in year two, 3% in year three all the way down to 1% in the final year.

So, if you owe £250,000, that’s a whopping £12,500 in year one, £10,000 in year two, tapering down to £2,500 in the final year of your five-year fixed rate.

Therefore, you need to do the sums to work out whether it’s worth your while repaying your loan early.

I don’t have to pay ERCs – should I press ahead?

Even if you don’t have to pay ERCs and have the cash, you need to ask yourself a few additional questions before diving in.

Firstly, do you have enough savings to cover emergencies, such as losing your job or unexpected car or home repairs?

Experts recommend that you have at least three to six months’ worth of living expenses in an easy-access account to cover unexpected expenses. You should prioritise this safety net before overpaying on your mortgage.

Next, ask yourself: am I carrying high-interest debt such as personal loans or credit cards?

If the answer is yes, it usually makes sense to clear those first, as they tend to charge higher rates of interest than your mortgage.

After that, you need to ask yourself whether your money could be working harder elsewhere.

Compare the rate on your mortgage with the rate available on high-interest savings accounts or investing.

As a rule of thumb, if your mortgage rate is higher than the interest you can earn in a savings account, overpaying your mortgage may make sense.

Let’s return to the example above, where you have a £250,000 mortgage on 4.5% over 25 years, and you want to pay £10,000 off your loan in a lump-sum.

For the sake of this example, let’s also assume that you’re a basic rate taxpayer and the best savings account on the market pays 5%.

Paying an extra £10,000 off your mortgage would save you £19,450 in interest and shave one year and nine months off your term.

However, you would still be £3,080 worse off paying £10,000 off your loan than if you’d put it in a 5% savings account, even though your mortgage would be cleared in just 23 years and 3 months.

That’s because over that time your savings would be worth £31,360, which would be more than enough to repay the remaining £28,280 left on your mortgage balance – and leaving you £3,080 spare.

If you’re unsure whether you’d be better off repaying your mortgage or saving your money instead, moneysavingexpert.com has a handy calculator you can use.

Investing in the stock market could also offer better long-term gains – typically 5-7% a year after inflation – but it carries risk, and returns aren’t guaranteed.

Whatever your choice, it’s worth speaking with a mortgage broker or financial adviser to get tailored advice. 

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I’m going ahead with it. How do I do that?

Most lenders make overpayments pretty straightforward. You can either ask them to increase your monthly direct debit or make one-off payments via your online account or over the phone.

If you prefer a more flexible approach, making lump-sum payments when you get a bonus or extra income might work better for you.

Are there any clever ways I can build up my cash savings to pay off my mortgage early?

There are ways you can increase your monthly repayments without feeling the squeeze.

For example, every time you get a pay rise, put the extra cash straight towards your mortgage. You won’t miss the money – after all, you never had it to begin with.

But as outlined above, you need to ask yourself whether you’d be better saving that money or paying down other debts instead.

There are also apps to help you overpay your mortgage. Accelerate My Mortgage and Sprive, for example, combine cashback and Artificial Intelligence to give you the tools to pay off your mortgage earlier.

Disclaimer: Mouthy Money has not tried either of these apps, so make sure you do your homework before you sign up to anything.

Alternatively, banks like Monzo and Starling offer ‘round-up’ features. If you buy a coffee for £2.60, the app rounds it up to £3 and squirrels away the 40p difference in a separate savings pot. Over time, these small amounts can add up and be used towards overpayments.

The best part is you barely notice it happening – but your mortgage balance certainly will.

Mortgage-free life

Paying off your mortgage early can feel like an incredible achievement, but it’s not a one-size-fits-all decision.

Make sure you’ve got an emergency fund, cleared any expensive debts and considered your long-term goals. Then speak to a mortgage broker to help weigh up your options.

And if you do decide to go for it, congratulations – you’re one step closer to financial freedom.

Photo by RDNE Stock project