Preparing for retirement can be a daunting task, and one of the biggest financial decisions you may have to make is whether or not to pay off your mortgage early.
Covering mortgage payments out of your pension income can be a real struggle, particularly when mortgage costs and other household bills have risen substantially in recent months. Although mortgage rates are showing signs of stabilising, some lenders have raised their fixed rates again recently and they remain significantly higher than they were a year ago. According to financial website Moneyfacts.co.uk, the average standard variable rate (SVR) is currently 7.30%, compared to 4.61% a year ago.
Here, we look at some of the advantages of paying off your mortgage early, how you might be able to do this, and a few of the things you need to consider in the process.
Speaking to an experienced mortgage advisor can help you to understand your options and get a great deal on your mortgage. If you’re looking for expert mortgage advice, you can speak to an independent mortgage broker with Unbiased. Every advisor you find through Unbiased will be FCA-regulated, qualified and unconnected to product providers – so they can offer you truly unbiased advice.
Advantages of paying off your mortgage early
Your mortgage is probably your biggest financial commitment, and if you can afford to pay it off before retirement, doing so often makes sense. Here are the main reasons why:
You’ll reduce your monthly outgoings
You’ll ease pressure on your household finances if you don’t have to make monthly mortgage repayments from pension income, and this may enable you to focus on funding your retirement. After all, pension income tends to be lower than the amount you received during your working life, so you may have no option but to reduce your outgoings ahead of retirement. Find out more in our articles Can you afford to retire? and Your pension options at retirement.
You’ll save thousands in mortgage interest
One of the biggest advantages of paying off your mortgage early is that you’ll save a substantial amount of money on interest payments. The sooner you pay off your mortgage, the less interest you’ll pay over the term of your mortgage. This could amount to thousands of pounds, especially if you have a large mortgage or long repayment term.
You don’t have to pay off your entire mortgage balance to pay off your mortgage early. Instead, you may choose to make regular or lump sum overpayments from your income or savings as you approach retirement. Making overpayments still means that you’ll pay off your mortgage early.
For example, let’s say you have a savings balance of £10,000 earning £350 a year in interest in an account paying 3.5%. If your £150,000 mortgage was fixed at 5% with 10 years left to run, you could reduce the term by 10 months and save about £6,100 in interest by overpaying £10,000 of the mortgage now, and continuing to make the same monthly payments as before. You can find out the pros and cons of overpaying your mortgage in our article Should I overpay my mortgage?
You can focus on enjoying retirement
Your retirement may be a time when you want to pursue hobbies, spend more time travelling, and with your family. By paying off your mortgage early, you can free up a large amount of disposable income that can be used to fund your lifestyle. Having more spare income could also provide a financial cushion in the event of any unforeseen expenses.
How to pay off your mortgage early
There are a number of ways that you might be able to use to pay off your mortgage early. Which is most suitable for you will depend on your personal circumstances.
As explained, you could consider putting any spare cash towards paying off your mortgage early, or making mortgage overpayments. However, this is usually only beneficial if your mortgage rate is higher than the rate you’re receiving on a savings account.
Alternatively, you may want to consider equity release, although this option definitely won’t be right for everyone. Unlocking some of your property wealth could give you a lump sum to pay off your mortgage, without needing to sell up. An equity release plan is essentially a loan that must be paid back, with any interest owed, when you die or move into long-term care. You must be over 55 and own your own home to be able to apply. Find out more in our article Should you use equity release to pay off your existing mortgage?
If you’re looking for somewhere to start, you can get expert advice from an independent equity release specialist with Unbiased. They’ll listen to your needs and talk you through your options, so you can decide if equity release is the right option for you.
There are pitfalls to beware of when it comes to equity release, however. Equity release will reduce the value of any inheritance you might have planned to leave, and it could affect your entitlement to means-tested benefits. The impact of compound interest should also be considered. As you’re not paying off either the loan or the interest on the loan, the amount that you owe builds up at a greater rate each year than if you were making repayments. Read more in our article Equity release – what is it and how does it work? It’s worth noting, however, that equity release plans have become much more flexible in recent years, so you can now make repayments if you want to.
Alternatively, you may decide you’d prefer to downsize or moving to a cheaper area to raise a cash lump sum that could be used to repay your mortgage. Read more in our article Five questions to ask yourself if you’re considering downsizing.
If you don’t want to move, or use equity release, you may still be able to reduce your mortgage costs by looking around for a new deal to help lower your repayments, such as a retirement interest-only (RIO) mortgage, for example. A RIO mortgage can significantly reduce monthly repayments, as you only pay the interest on your outstanding mortgage balance and not any of the capital back each month. You can find out more in our guide Mortgages for over 50s: What you need to know and How retirement interest-only mortgages work.
Things to consider
Before paying off your mortgage or making overpayments, there are several things you need to consider that could affect your decision:
You may have to pay early repayment charges (ERCs)
The majority of mortgage lenders allow you to overpay your mortgage by up to 10% of your balance each year. However, breaching this limit could result in an early repayment charge. These typically amount to a percentage of between 1 and 5% of your outstanding balance, and fall over time. If you repay a £100,000 mortgage early, for example, and pay a 2% ERC, this will amount to £2,000. ERCS can be a hefty sum, so you might decide that it’s not financially wise to pay off your mortgage early. Check your mortgage terms and conditions to see if there’s an ERC in place, and how this works. If you’re unsure, contact your lender for more information and examples of how this would work.
You could miss out on growing your money elsewhere
Inflation, or the rising cost of living, erodes the value of your savings over time. If you pay off your mortgage before the end of its term, you could miss out on the opportunity to grow your money elsewhere. For example, investing the money in your pension may produce greater returns over the long term, and into retirement, which may last for decades. Investing is not without risk however, and there’s a chance you could get back less than you put in. Find out more in our articles How does inflation affect my pension? and Where is my pension invested?
If you use your savings to pay off your mortgage early, you can’t get this money back. That means if you face an unexpected emergency expense, such as damp-proofing your home or installing a new boiler, for example, you might have to use all your emergency savings to pay for this.
In the worst case scenario, this may mean that you end up having to take on expensive additional borrowing to meet costs. If you are considering paying off your mortgage, it’s therefore vital to consider whether you’ll still have savings available for emergencies. Experts recommend having the equivalent of at least three to six months’ worth of income in an easy access account, and ideally more in retirement.
Speaking to an experienced mortgage advisor can help you to understand your options and get a great deal on your mortgage. If you’re looking for expert mortgage advice, you can speak to an independent mortgage broker with Unbiased. Every advisor you find through Unbiased will be FCA-regulated, qualified and unconnected to product providers – so they can offer you truly unbiased advice.
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