Here at Infinity we are not fans of debt and we usually advise that the first step in taking control of your finances is to pay off your debts. However, when it comes to a mortgage, different rules apply.
A mortgage enables you to increase your net worth over the long term by acquiring an asset, and that’s what differentiates it from unsecured debts such as credit cards and certain other types of loan. That’s why a mortgage with affordable monthly payments is considered ‘good’ debt.
A secured loan on a home is the biggest debt that most people will acquire in their lives and for many attaining mortgage-free status is a major goal. However paying off your mortgage early may not always be the best policy. You need to look at the bigger picture to work out whether it is worth your while or not.
Six questions to ask to determine whether you should pay off your mortgage early
1. Do you have other debts?
We are back to the concept of good and bad debt here. Unsecured loans, credit cards and store cards will have higher interest rates than your mortgage and will cost you much more to pay off. If you have disposable income to divert towards debt repayment, definitely deal with those high interest debts before reducing your mortgage. And once they are dealt with, bin the credit and start living within your means.
2. Are your family protected with insurance?
Wealth protection is a crucial part of financial planning. Health, life and critical illness insurance are all types of cover you should consider to protect your family against life’s unforeseen events such as your premature death or an accident or illness which mean you can no longer work. Don’t start paying off your mortgage until you are satisfied that you have adequate insurance in place. If you aren’t sure, one of our financial advisers would be happy to review your cover and work out if there is any shortfall. You can contact us for an appointment at any time.
3. Is your pension on track to meet your retirement needs?
It is crucial that you work out how much you need to save and invest to meet your retirement needs and regularly check that you are on track. You should definitely prioritise pension saving over paying off your mortgage if you have any doubts at all about your ability to support yourself when you stop working.
Depending on where you are living and the tax relief available to you, pension saving may be the most tax-efficient way to invest disposable income. In addition, if you are part of a company scheme under which your employer also contributes, you may be looking a gift horse in the mouth if you choose to pay down your mortgage early over increasing your pension contributions.
4. Can you get a higher return elsewhere than your mortgage interest rate?
Interest rates have been historically low for an extended period and that has meant that money invested wisely in stocks will have been generating a higher return that the rate of interest on most mortgages. To give a simple example, if you earn a 5% return on your investments and are paying 2% interest on your mortgage, it really doesn’t make sense to overpay on mortgage payments.
However, the times they are a-changing and many financial experts, including our colleague Gareth Lewis, Managing Director of Investment Strategy at Tilney, believe that interest rates will start rising in response to rising inflation. If interest rates rise significantly, paying off a mortgage may become more financially prudent, particularly in the current context of a fragile global economy characterised by job insecurity and growing unemployment.
5. Do you have an emergency fund?
We always recommend having easy access to enough money to cover your essential living expenses for six months. This emergency fund can be used to tide you over when your financial life is not going to plan, for example if you lose your job or become too sick to work. If you don’t have this sum tucked away, start saving into a ringfenced account before tackling the mortgage.
6. What costs are involved in paying off your mortgage early?
Check the small print of your mortgage deal to see if there are any penalties involved in paying lump sums. These could negate any benefits of early repayment.
As you can see, when considering whether or not to pay off your mortgage early you need to make the decision within the context of your overall financial plan. If in doubt, contact us for a free, no obligation assessment of your finances.
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