Overpaying can knock years off your mortgage

There is nothing to stop property buyers handing the borrowed money back at an accelerated pace once they have found their feet, writes Laura Slattery

Irish consumers are in the midst of a credit bonanza: average household debt is growing at an annual rate of 25 per cent, outstanding mortgage balances are increasing at a faster rate than ever before and forests have been felled to create leaflets advertising unsolicited credit offers, which are shoved into letter boxes around the country on a daily basis.

But for every first-time buyer snapping up the lenders' new offers of 100 per cent mortgages then whipping out their credit cards to furnish their brand new homes, there is another type of borrower, the kind who is deeply uncomfortable with the idea of debt and wants to get out of it as quickly as possible.

Debt is an inevitable consequence of climbing the property ladder for anyone who hasn't inherited a six-figure sum or blacked out the right combination of six figures on their Lotto cards.

The consensus is that the mortgage lenders are throwing money at people. But even if that's true, there is nothing to stop property buyers handing the money back at an accelerated pace once they have found their feet.

Overpaying a mortgage can be done in three ways.

The first two methods - by making occasional lump sum overpayments or by arranging with your lender to make regular monthly payments over and above what they strictly demand - can be done by anyone on a standard variable rate or tracker mortgage.

The table below shows exactly how much could be saved in interest if borrowers were to start making once-off overpayments, annual lump sum overpayments or regular monthly overpayments on top of their normal mortgage repayment.

Most dramatically, someone repaying a mortgage of €300,000 over a term of 35 years at an interest rate of 3.1 per cent will knock over five years off their term and €28,267 off their total interest bill if they start making monthly overpayments of €150 after five years.

Most lenders will allow borrowers on variable rate loans to make overpayments if they arrange to do so in writing, and, as interest rates have come down in recent years, some borrowers comfortable with their repayment levels have written to their lenders, asking them to keep their direct debits at the same rate, effectively kick-starting an overpayment habit.

Borrowers who were attracted to the security of long-term fixed-rate mortgages may run into trouble if they try to overpay their mortgage. Penalties will apply if they overpay by more than a certain amount, if they redeem the mortgage early or if they convert to a variable rate loan in the middle of the term.

The potential savings and term shortenings shown come with several caveats. First of all, the savings don't take into account the effects of inflation. If, for example, inflation were to run at 2 per cent per annum over the period, the "real" savings to be had for someone who starts overpaying their mortgage by €150 after five years would be a more modest €17,349.

Secondly, the calculations assume that the interest rate charged remains at 3.1 per cent for the duration of the mortgage.

If interest rates rise, borrowers who have made as many dents in their outstanding capital as they could afford in times of low interest will be in an even more comfortable position.

The monthly repayments also do not show the benefit of mortgage interest relief, which would lower a first-time buyer's repayments by €67 a month. Based on the current interest relief ceilings, this would reduce to €42 once they no longer qualify as a first-time buyer (after seven years).

Simple affordability will be the biggest barrier for many borrowers, who will try to borrow as much as they can possibly afford to repay in order to secure their footing in the frenzied housing market.

But while most borrowers will be stretched to their limits in the early years, as they get older and their earnings increase their mortgage repayments should, in theory, become more manageable, leaving scope for a more pro-active approach to repayments.

According to a recent survey by IIB Bank and the Economic and Social Research Institute (ESRI), only 15 per cent of homeowners describe their mortgage repayments as "a heavy burden".

Almost 55 per cent described their mortgage as "somewhat of a burden", but that still leaves 30 per cent of people to whom repaying their mortgage is no burden at all.

Not everyone with spare cash hanging around will want to plough it into something as boringly sensible and intangible as whittling down their mortgage, even if the interest savings are substantial.

On most mortgages, once an overpayment is made, borrowers won't be able to access that cash again without paying top-up or equity release fees, which can vary from €200 to over €1,000.

So, understandably, homeowners will want to build up an easily accessible savings fund for emergencies before they commit to overpayments. (Advisers recommend a fund of between three and six months' expenditure.)

But there is a third, more flexible way, of ridding yourself of an intimidating mortgage as efficiently as possible without having to pay legal fees if you need to get the cash back.

Special types of loans called offset or current account mortgages allow homeowners to automatically credit any money they have in their current or savings accounts against their outstanding loan. As the interest on the outstanding loan is calculated daily, any credit such as a salary payment has the effect of reducing the interest payable, even if the money is quickly spent.

The exact interest savings and shortenings of the mortgage term will depend on the discipline of borrowers, as well as their level of earnings.

NIB and First Active are the only two lenders offering these mortgages. NIB's offset mortgage allows customers to credit up to six current accounts and six savings accounts against the loan. First Active's current account mortgage is more basic, with just one current account balance credited against the loan, and a smaller range of banking services. But while First Active's loans are available over terms of up to 40 years for younger borrowers, the NIB offset mortgage is only available over terms of up to 25 years.

This will deter first-time buyers, especially those in the Dublin area, who want to borrow as much as they can by spreading their repayments over as long a term as possible.

And the shorter maximum term means that someone who starts out with a normal repayment mortgage over 35 or even 40 years but likes the idea of NIB's offset mortgage will find it almost impossible to switch into it later, unless they make hefty lump sum overpayments beforehand.

But no matter how they approach it, overpaying a mortgage makes sense if homeowners can afford it.

With the growth in house prices slowing down, a new generation of housebuyers could find that they have less equity to play with down the line, preventing them from moving out of their starter homes into something more spacious. Making higher than required repayments could be the only way to build up sufficient equity to realise their trading-up ambitions.