Miss Thrifty’s Mortgage Masterplan (cough)

In a couple of posts last autumn, I wrote about the challenges of trying to remortgage when you are, well, anyone right now. I found that as the weeks passed, lenders’ demands of their mortgage customers became increasingly unrealistic.

Firstdirect wouldn’t lend to us because there are three people listed on our mortgage. Abbey, our current provider, would only offer us a new fixed rate deal with an interest rate of 6.99 per cent, plus a £724 arrangement fee. (Erm, no thanks.) Right now only those with lots and lots and lots of equity in their homes are able to claw the few fixed rate deals that remain.

In the end we decided to sit it out and allow our mortgage to slip onto the standard variable rate once our fixed rate expired last month. This has turned out to be an interesting move: back then (September 2008) Abbey’s SVR was 7.04 per cent. Now it’s 4.51%. In real terms, our monthly mortgage payments have fallen by nearly £200.

Mortgage Masterplan

So being on the SVR is rather tasty at the moment. The interest rate is low; what is more, we can make overpayments without attracting any additional bank charges. This is our masterplan: to overpay as much as we can, to reduce our mortgage by as much as we can as swiftly as possible.

We are currently overpaying the mortgage by £500 a month; it sounds like an awful lot to take on, but it isn’t really. This is because we’re used to funnelling away lots of cash to pay off that debt. Now that we’re (non-mortgage) debt-free, it makes sense to keep putting that money by; it’s habit, so it isn’t as if we’re going to miss the cash.

There are two reasons for overpaying like this.

1. We can become mortgage-free more quickly.

The overpayment comes off the principle (the amount that we owe the bank) rather than the interest (the hefty slice of every mortgage repayment taken by the bank for itself). By overpaying £500 every month, we are reducing our principle by an extra £6K a year.

There’s more to it than that, however. That £684 that we’re paying every month come rain or shine? Well, only around £200 of that amount goes towards reducing that principle amount. The remainder – nearly £500 – is swiped by the bank as its interest payment. (Yes! I think it’s outrageous too.)

So when we’re overpaying that £500, we aren’t just reducing the principle. The bank charges us interest on the sum owed; by reducing the sum owed, we are also reducing the interest charged.

In a nutshell: if we continue to overpay by £500 every single month from now onwards, we will be mortgage-free in half the time! (2019, instead of 2032.) We will also save around £43K in bank interest payments. What’s not to like?

2. When interest rates begin kicking off again, we need to be ready.

Yep: this is where I go dark on y’all. The idea that our mortgage could be paid off in 2019 is a lovely one, but it’s soaked in utopia. It presumes that we will both remain in gainful employment with regular incomes. It presumes that nothing else dreadfully dramatic and unexpected will happen to the economy; a rather optimistic presumption, given that the bizarre events on the world markets in 2008 caught everyone on the hop. Crucially, it presumes that interest rates are going to stay ridiculously low.

The fact of the matter is, what goes down must come up. The Bank of England is slashing the interest rate – but at some point, probably around the 2010 mark, that interest rate is going to begin ascending. And when it does, the SVR isn’t going to be as attractive an option as it was. Cue a scramble for any half-decent mortgage deals that are still about.

So perhaps the idea that our mortgage can be paid off in 10 years is nothing more than a fantasy.

But there’s another problem too. Property prices are plummeting. This means that unless we overpay, the equity in our home isn’t going up. It’s going down. Right now our home’s loan-to-value ratio stands at around 88-90 per cent. Which is okay. But it isn’t going to get us a good fixed rate mortgage deal. And if we don’t overpay and house prices continue to slide, we could find ourselves in negative equity before we know it – meaning that we would have trouble getting any mortgage deal. The worst case scenario: we would be trapped on a soaring SVR. And who knows how high interest rates will go, once they do start rising? After all, who would have thought that the interest rates could possibly have gone as low as they have? Anything is possible.

By overpaying, hopefully we can maintain the equity in our house and get a new mortgage deal if and when the time comes.

So there you go: a mortgage masterplan that is either a delicious pipe dream or a grim survivalist mission, depending on which way you want to look at it.

What I will say is that I am not a mortgage expert – so if you disagree with any of these points or ideas, or if you think that I have missed something important or of interest, please pipe up!

Update: This post was selected for the Carnival of Personal Finance: World Record Edition.

Photo credit: tinywhitelights.