Paying off your mortgage early might seem like a no-brainer to most people. However there are a few important things to consider before you start to throw money at your bank.
Whether you’ve built up excess savings, got a big bonus, received an inheritance or won big at the races, you may be in the lucky position to knock a chunk off your mortgage or overpay by a set amount each month.
And although overpaying on your mortgage is usually a good idea as it means you’ll potentially save tens of thousands of euro in interest and be mortgage-free quicker, there are a few things to consider.
1. Do you have a rainy day fund?
Most experts advise that you have a rainy day fund that’s equivalent to around six months of your net disposable income.
So if you take home €3,000 a month after tax, ideally you should have around €18,000 in an easy-access savings account for emergencies.
If you don't have an adequate amount of savings, you should consider building up your savings before you look at paying extra off your mortgage.
2. Will you need to borrow in the near future?
Your mortgage will likely be the cheapest form of debt that you have.
That’s because, unlike other loans, it’s secured lending (your home is used as security against your mortgage and technically the bank can take back your home and sell it if you don’t make repayments over a long period of time).
Most people will be paying between 2.5% and 5% interest on their mortgage. This compares to personal loan rates of around 8% to 10% and credit card rates of up to 20% or more.
There’s no point in paying a chunk off your mortgage if you’re going to have to borrow at a much higher rate for some home improvements or a new car a few years later.
3. Do you have existing debt?
If you have other more expensive debt then you should pay this off first.
There’s no point in paying €25,000 off your mortgage which is charging you 4% interest if you also have a €25,000 car loan that’s charging you 10% interest.
If you have extra money, you should always look at paying off your most expensive debt first, which is unlikely to be your mortgage.
4. Will you be penalised?
If you’re on a fixed rate and pay off your mortgage early, or even just overpay, you may be charged a fee.
The charge will depend on your lender and how many years you have remaining on your mortgage.
However some lenders now allow you to overpay up to 10% of the outstanding balance on your mortgage each year without incurring a fee. And if you’re on a variable rate, there’s usually no issue with overpaying.
Either way, always check carefully with your lender about any potential fees or charges before you overpay so that you make the right decision.
5. What is your savings rate?
If you have money saved or invested somewhere that’s making a good return, it might be better to keep your money where it is.
For example, if your savings are making a return of 7% or 8% a year, and the interest rate on your mortgage is only 2% or 3%, it wouldn’t make financial sense to use your savings to pay off your mortgage.
6. Think about liquidity
We've all heard of the expression “asset rich but cash poor”.
It might be great to live in a home that’s worth half a million and be almost entirely mortgage-free, but if you’ve got no money for emergencies, holidays, or unexpected health expenses then you could still find yourself in trouble financially.
Some people can be too aggressive in trying to pay off their debt and it can end up backfiring. So consider how much easy access to money you think you’ll need in the short to medium term.
How to overpay?
If you decide to overpay on your mortgage an important thing to consider is how to apply the overpayment. As you have two main options:
1. You can keep your mortgage term the same but reduce your monthly repayments.
2. You can keep your mortgage repayments the same and make a lump sum payment off the capital balance. This will reduce the term of your mortgage and mean you're mortgage-free quicker. This option is usually recommended as you'll pay less interest overall.
Either way you should give clear instructions to your bank.
Get good advice
Whether to pay a lump sum off your mortgage will come down to individual circumstances. As what's right for one person may not be right for the other.
But whatever you do, make sure you get good financial advice before making a decision so that you do what's best for you.
