Emma is 35 and self-employed. She has no pension and took out a €250,000, 30-year mortgage three years ago. In two years' time, her Special Savings Incentive Account will reach maturity, giving her a lump sum of €20,000. What should she do?
Clear debts or save for retirement?
Emma can shorten her mortgage term by three-and-a-quarter years if she uses the €20,000 to make a once-off lump sum overpayment in the sixth year of her mortgage, according to figures generated by a mortgage calculator on www.simplymortgages.ie.
This will save her a total of €23,508 in mortgage interest, based on an interest rate of 3.4 per cent.
If the payment is made in year 16 of her mortgage, she will shorten her term by just two years and four months. The interest savings, however, are still substantial, at €11,469.
This scenario ignores the effects of changing interest rates. But interest rates are currently very low: if rates increase, the savings available are likely to be even higher.
On the other hand, Emma has no provision for her retirement, meaning she will have to rely on the basic State pension, currently €167.30 a week.
Say she decides to invest the €20,000 into a Personal Retirement Savings Account.
To keep within the tax relief limits available on pensions, Emma invests lump sums of €5,000 over four years.
At the age of 65, assuming investment growth at a rate of 6 per cent per annum, Emma's pension fund will be worth a gross €105,478.
As she pays tax at the top rate of 42 per cent, she also makes tax savings of €8,400 during the four years she has invested the lump sum into the pension.
This scenario, however, ignores the significant effects of fund management charges on the pension.
Paying off fixed-rate mortgages
James took out a 20-year mortgage for €200,000 a year ago, opting for a fixed-rate mortgage for the first five years at a rate of 4.5 per cent. He has now inherited a lump sum of €25,000 and wants to use this amount to reduce his mortgage debt but is worried that he will incur huge penalties for exiting the fixed-rate mortgage early.
Because James has a fixed-rate mortgage, he will have to pay a redemption fee if he wants to clear off part or all of the loan.
Most institutions follow a formula where the redemption penalty is based on the difference between the fixed rate he is paying and the current fixed rate that applies for the remainder of the loan at the time of the redemption, in this case four years.
So if the four-year fixed-rate at the lender is now 4 per cent, the penalty James pays is 0.5 per cent (4.5 per cent - 4 per cent) for each year left in the fixed rate multiplied by the amount of the redemption.
This works out as €500. But the lender may also charge an administration fee for breaking the terms of the fixed rate.
Mortgage and personal loan customers have contacted The Irish Times questioning the size of fixed-rate redemption penalties.
In one case, a homeowner was told during one phone call that the cost for completely clearing his loan would be €600, only to be later informed that the actual penalty was €5,000. The institution concerned eventually backed down and charged €600.
Homeowners in this situation should first of all ask for a written explanation of how the lender has arrived at the value of the penalty.
They should also consider threatening to move their business to another lender if they believe they are being charged penal administration fees on top of any redemption penalty.
If further lump sum payments are planned, they should avoid fixed-rate mortgages, which are generally inflexible.
Current account mortgage versus variable rate loans
Matthew and Kate want to take out a joint mortgage for €300,000 over 30 years. Their combined net monthly income is €5,000 and their net monthly expenditure is €4,500.
Should they opt for the cheapest loan available to them - a tracker mortgage at a rate of 3.1 per cent on offer from five lenders - or try First Active's current account mortgage at a rate of 3.29 per cent?
According to First Active, if Matthew and Kate spend their combined net salaries of €5,000 evenly during the course of each month and let the €500 left over be classed as an overpayment, the effect of that money resting in the current account is to reduce the total interest payable by €74,242 and to shorten the mortgage term by almost 12 years.
The couple's regular monthly repayment is €1,312, a little higher than it would be on a straightforward mortgage with a rate of 3.1 per cent, where it would be €1,281
However, the total interest the couple would pay on the current account mortgage is €98,155, compared to €161,177 on the straightforward loan - which means that they would save a total of €63,022 by opting for the current account mortgage.
But if Matthew and Kate were spending the bulk of their salaries as soon as they were credited to their current account and regularly using the product's pre-approved overdraft facility, the savings generated by using the First Active mortgage wouldn't be anywhere near so great.
The financial benefit of the current account mortgage therefore depends as much on the discipline of the customer as it does on therate of interest.
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