Saving Vs Reducing Your Mortgage

No saving zone

It’s a no-brainer; now is the time to start making overpayments and reduce the bain of the average homeowners life, the mortgage. This especially applies to those still in their initial fixed rate period (honeymoon period). Unfortunately, there are no real signs of the credit crunch improving anytime soon, and there’s certainly no sign of the lenders’ variable rates tumbling. If anything, they’re continuing to climb.

What to do? Forget saving, start making mortgage overpayments. Why? Because spending will cost you less. Everyone say it with me:

spending will cost you less

The current problem for homeowners

The main problem at the moment is that a lot of cowboys and cowgirls took out 100% mortgages; with the hope of the property market rocketing one precise way- UP! The cowboys considered that 100% mortgage a lucrative investment, which would eventually secure their future.

Ha. If only it were that easy. If only we paid more attention in Science when Isaac Newton cropped up in the text book. He’s the chap that sensibly proved, “What goes up must come down”– the law of gravity. It’s a basic concept which flew over the average UK citizen. I don’t know whether to laugh or cry.

This is what happened…the story so far

I’m sure you all know the story by now; it’s become a classic tale. I’m sure we’ll be telling it to our kids, just as we tell our kids about ‘The boy who cried wolf’

Once upon a time…House prices shot up for 7 years; during the 6th and 7th year people took out 100% mortgages thinking prices would continue to rocket so they could live happily ever after. To their despair, this fairytale took an unorthodox twist. The clouds turned grey, and prices started to tumble. Consequently, a large portion of the country are suffering from a contagious bug known as “negative equity”. Moral of the story? Don’t be an idiot.

Negative Equity Explained

It’s simple. You purchased a house last year on a 100% mortgage. The property was worth 100k, and you took out a 100k mortgage to purchase it. A year later, the property is worth 95k due to 5% a drop. Now, you still owe 100k on the property, but it’s actually worth 95k. That’s negative equity of 5k. Oopsie? Indeed.

Now that’s not actually the main problem. The problem is when everyone on an initial fixed rate mortgage is thrown into reality and slides into their lenders standard variable rate. A concept which a lot of borrowers ignored; their vision was probably impaired by imaginary pound signs.

Reality? The initial fixed rate started at 5%, which was very cool. The average burger flipper can keep up with that payment. After 2 years of making interest payments at 5%, the SVR kicks in, which is touching the 7.8% mark. Now, that’s not like your cheeky little 1p increase in petrol. We’re talking about an increase of hundreds of pounds here. What are your options? You either a) ask your lender for a better deal b) remortgage.

Unfortunately, it could go all tits up from here because you’re in negative equity, remember? Since the credit crunch started slicing like a swinging hammer, lenders are reluctant to toss away 100% mortgages like candy anymore. In fact, I don’t think any commercial lender offers a 100% mortgage anymore, so a lot of people will have no choice but to cough up the extra interest rate payments or sell up. You’re in quite a pickle, innit.

Prevention

Right, so you’ve got a stupid mortgage and you’re feeling rather stupid. What do you do? Well, forget saving those pennies. Pay off your mortgage, or at least reduce it as much as you can. Ideally, start doing this as as soon as possible (way before you’re due to jump onto the SVR bandwagon).

Debts usually cost more than savings earn you in interest, so cancel them out and you’re better off. I actually proved this when I saved 15k and reduced one of my mortgage’s. By reducing my mortgage by 15k I actually saved myself 30k in interest rate payments over a 25yr period.

Here’s an example from moneysavingexpert.co.uk of why reducing your mortgage makes sense over saving:
No saving zone

Buying more property instead of clearing debt

I know a lot of “power investors” that keep buying property on interest-only mortgages, with 90-100% mortgages. Back in the day when the property market hadn’t reached it’s peak, it was an extremely lucrative method of making money. However, those times are over, and it’s still as risky today as it was 5 years ago- because you never know which way the market will swing.

My boss, as a prime example, is a mini-power investor. He swept up 3 or 4 properties in the space of 1 year, all on 90-95% interest-only mortgages. And now? He’s going to struggle as soon his standard variable rates kick. I’m not sure if he’s in negative equity, but I suspect he maybe creeping close to the danger zone.

It’s funny; he used to try and convince me to continue buying property, and usher away the thoughts of reducing mortgages. His plan is to buy up as much brick and mortar as possible, because he believes he’ll end up making more by investing in multiple properties, as opposed to investing in the same few properties. He even demonstrated this by fancy little formulas in an excel sheet, which showed how his method was more lucrative. While his figures stacked up and looked prettier than a meadow in the summer, I wasn’t about to get suckered into his tactics. I knew the market couldn’t keep going up, and I know when shit hit the fan there’s going to be a crucifying period where the strings start to get a little too tight. Granted, if you pull through the tough times you’ll come off a rich man. But who knows how long, and by how much the market will drop by? He certainly didn’t, and still doesn’t.

And now? He’s in a position where he won’t be able to remortgage without investing more money into his properties (I don’t think), and he’ll soon be thrown onto the death pit of SVR rates, which will increase his monthly costs to an amount he won’t be able to keep up with unless he decided to make regular visits to a sperm bank. He’s in trouble.

Unfortunately, regardless of the climate and his current position, he still thinks his milkshake is better than mine….

my milkshake is better than yours

Believe me; I tried warning the naive little duck.

My property investment strategy works

Ok, seems like a perfect time to start praising my personal method of investing (again). I’ve already talked about my strategy in detail, but I’ll just go over it in brief once more.

I invest in property safely. How? I put down 15-20% deposits, and I make sure my rental figures stack up. I make sure the rental income is high enough to cover a repayment mortgage! I don’t do “interest-only” mortgages because I don’t like the idea of owning a property for 20 years and relying completely on a healthy market to pull me through with a profit. I like knowing that regardless of which way the market sways, I would have cleared my mortgage by the time my mortgage is due to end.

I’m not a smart investor; I just play it safe like Aunt Daisy. I’ve always tried explaining this to my boss, but I don’t think he ever got it. He knew what I was doing, and he knew why I was doing it, but it seemed way too safe and unprofitable for him. One thing is for sure, I’m sure I’ll find the next year or so much more comfortable than him.

The power of repaying mortgages

So, ultimately, you can’t lose by repaying mortgages, even if that means making small monthly overpayments. Why?

  • The less debt you have, the more “house crash proof” you are
  • It’s easier to remortgage if you don’t fall into negative equity
  • Over time your monthly payments will reduce
  • The less debt, the less you spend on interest rates

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