From time to time, you hear of little celebrations: "I finished paying my mortgage this month!" On enquiry, you find that they won't really be much better off; their mortgage payments being £25 per month, or some incredibly low figure compared to a typical mortgage payment when you buy a house today.
This repayment amount presumably was a considerable burden on the monthly outgoings when the mortgage was taken out. The repayment schedule is not affected through the years, but due to general inflation, the amount becomes a less significant fraction of the income towards the end of the term.
While it is clear that over-paying the mortgage in the early years will drastically reduce the interest paid, is it worth bothering when the actual "cost" of the mortgage will probably decrease to such an extend that in 30 years you won't even notice the payments?
I'd get out a spreadsheet and play with some numbers...if I ever have enough spare cash to have to decide whether to pay back early or not.
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So curiosity got the better of me.
ReplyDeleteThe problem is: paying back early means that the extra pounds that you pay with are the most expensive ones.
Assuming a £90k mortgage for 25 years at 4.75% interest we get the following examples:
The total amount paid is: just short of £154k. That is, you pay back about 1.7 times what you borrow over the lifetime of the mortgage.
However, if you consider inflation at 3% then the cost of the mortgate "in today's money" is only £108.4k. So you only really pay a value of 1.21 times what you borrow.
Frustrated at £356 interest compared to the slow capital repayment of only £156 per month? If you pay 25% extra for the first 2 years (an additional £3078 over 2 years) then you save about £6k over the term and shorten the loan by 1.5 years.
Considering inflation, the actual saving "in today's money" is only about £1400, since the £513.11 payments at the end of the mortgage are only worth about £126 of today's sterling.
So is it worth it? Pay an extra £3000 today so that in 23.5 years you will have saved £1400? Probably not.
Interestingly, if you pay 1.5 times the rate for the whole of the term, then you do pay it off in 13 years and an inflation-adjusted cost of about £100k, which isn't far from the £90k principal amount that we are taking about.
I can't quite model this in my head: Is that a ROI of 47% or 147%? If the latter, it's pretty good!
ReplyDelete... and doesn't it still compare favourably to doing anything else with your money? Since savings are also devalued by inflation, PLUS having lower loan-to-value improves the mortgage deals you can get when you refinance... hmmm...
>I can't quite model this in my head: Is that a ROI of 47% or 147%? If the latter, it's pretty good!
ReplyDeleteAs a ROI, it would be 47% over 23.5 years, which isn't that good.
Of course it's true that savings would also be devalued by inflation, so if you have sufficient cash in savings then pay off your higher interest debts...
However, if you had a bit of extra cash today, would you invest it on the mortgage or on "good food and wine"?