Homeowners across the UK are seeing their mortgage repayments go through the roof, as the fixed-rate deals they had finally come to an end.
According to the Resolution Foundation, the average household will see mortgage costs go up by £2,300 each year when their current deal finishes.
Five-year fixes have been the norm since 2016, only waning in popularity as interest rates started to rise at the end of 2021 and, between the start of 2022 and the end of 2024, the think tank estimates that 1.6 million households will see their deal end.
Somebody coming off a five-year fix in the next few months could easily see their rate jump from 2% (or less) to an 8.5% standard variable rate. Even by switching to a better deal, they might still end up paying 6% or more.
Increases like this will be challenging for all borrowers. But for older borrowers, who might only have a smaller outstanding loan, there could be an argument for paying the mortgage off – if they have access to the required capital – rather than remortgaging on to a higher rate.
How much can you save?
Take the example of a borrower with £50,000 and five years outstanding on their mortgage, who is coming off a rate of 2% and remortgaging on to a new fixed rate of 6.1%.
Their monthly mortgage repayments would jump from £876.39 a month to £968.97, according to mortgage broker Trinity Financial. Of that, £254.17 is interest – the rest capital repayment.
However, if our borrower had access to £50,000, they could pay off their mortgage and save themselves £15,250.20 in interest over the remaining five years of their loan.
In addition to the interest saving, our borrower would also be able to dodge a remortgage arrangement fee (which could be as much as £1,500 or £2,000 on the cheapest fixed rates), as well as costs associated with conveyancing.
The key, whenever you are deciding whether to save or invest your cash or pay off a debt, is to balance out the returns you’ll earn by keeping your capital invested, with the interest you are paying on your borrowing.
You should also consider any other charges – we’re discussing repaying a mortgage as an alternative to remortgaging, but if you’re on a fixed rate and your deal isn’t running out, you could face an early repayment charge if you pay it off early.
For paying off a debt to make financial sense over the long term, you need to be paying more in interest than you’ll earn if you leave your money where it is.
At the time of writing, the best five-year fixed rate ISAs were paying around 5.2%; you could get a higher rate potentially with a five-year fixed rate savings account, but your savings income would likely be subject to tax. This is because basic-rate taxpayers can only earn £1,000 in savings interest before it becomes taxable, while higher-rate taxpayers can only earn £500. If £50,000 was invested in a savings account paying 5.8%, it would earn close to £3,000 in interest over a year.
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It's trickier with money invested in the stock market, but over the long term it does typically beat cash, which might complicate your decision.
But cutting your interest bill might not be the only reason you want to pay off your mortgage.
A bigger motivation for many homeowners will simply be to bring their monthly expenditure down – either in the face of rising bills or, perhaps because they want to start winding down from work.
Our imaginary borrower would cut their monthly expenditure by almost £969 if they paid off their mortgage.
That will be a big draw for homeowners who may have been shackled to their mortgage for 20 or more years. However, if you do decide that’s what you want to do, it’s important you think carefully about which of your assets you raid.
Which investment should you cash in?
This is often the easiest pot of money to dip into, but if you’ve got a fixed-rate savings account, you’ll likely have to wait until it matures, otherwise you’ll be charged a penalty for early withdrawal.
You might have a share-holding or investment portfolio you can cash in. However, if it’s not held in an ISA, you might need to pay capital gains tax (CGT) when you cash it in. Currently, CGT will be charged on gains in excess of £6,000 a year at a rate of 20% for higher-rate taxpayers and 10% if you are basic-rate taxpayer (and your gain doesn’t make you breach the threshold for higher-rate tax). In April 2024, the threshold for CGT will fall to £3,000.
Money held in cash or stocks and shares ISAs can be withdrawn tax-free. This potentially makes them a first-choice pot to raid.
Since 2015, it has been possible to take lump sums out of your pension from the age of 55. However, it’s a tax minefield, so you need to tread carefully. You could take your 25% tax-free cash to raise the lump sum you would need to repay your mortgage, but to get your payment tax-free you would then need to ‘crystallise’ your pot by converting it to drawdown – even if you had no plans to take any income yet.
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Alternatively, you could make a so-called uncrystallised fund pension lump sum (UFPLS) withdrawal. Here, you can withdraw a lump sum and leave the rest of your pot where it is. The catch is that only the first 25% is paid tax-free, the remainder will be added to your overall income for the year and taxed at your highest rate of tax. Depending on your income and the size of your withdrawal, there is the risk that it could tip you into a higher-rate tax bracket for the year. You will also likely pay emergency tax on your withdrawal, although that can be reclaimed via HMRC. This means that you’ll have to factor tax into the amount you withdraw to ensure you have enough to clear your mortgage.
Another point to bear in mind when you make an UFPLS withdrawal is that the overall amount you can carry on paying into your pension will drop from a maximum of 100% of your earnings capped at £60,000 to just £10,000. This is the money purchase annual allowance, which replaces the annual allowance once you have made a taxable withdrawal from your pension. This could be an issue if you want to increase your contributions over time to make up for the money you’ve withdrawn.
Should you pay your mortgage off?
Whether or not clearing your mortgage is right for you is a very personal decision and depends on your personal circumstances.
A key factor will be how readily you can access the money you’ll need and the impact spending it could have on other financial goals. If you take money out of your pension, for example, it will be important to consider the impact it will have on your future retirement income. Even if you’re taking the money out of your ISA, you might have earmarked that money for other expenses.
If you aren’t happy losing access to your money, Peter Gettins, product manager at L&C Mortgages, says there could be an alternative way of reducing the interest you pay on your loan, rather than paying it off altogether. “It may be worth looking at an offset mortgage. These allow you to place the funds in a linked savings account so that interest is only charged on the difference between the savings and mortgage balances. You could potentially offset the entire loan and cut your interest charge to £0, while still being able to withdraw those funds should you need to.”
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