Repay Your Mortgage Early: All You Need to Know

In this post, we will look at the often debated topic of whether or not it makes financial sense to repay your mortgage early or not. We will consider this both mathematically and psychologically.

Dave Ramsay is one of the most popular personal finance ‘gurus’ in the United States and hosts a national radio program called The Ramsay Show which reaches 13 million listeners every week. He is famously against debt and his methods of wealth-building all revolve around this.

His preferred method for those looking to get their finances in check is known as The 7 Baby Steps. These are designed to get you out of debt and look like the following:

In this post we are going to be focusing the majority of our attention on baby step 6 and whether or not I feel this is the outstanding decision for the majority of us. Before that I will quickly run through my opinion of the other steps:

Baby Step 1 – Saving $/£1000 as an emergency fund is a great place to start. Highly recommend

Baby Step 2 – Paying off all debt apart from the house using the snowball method can be either good advice or poor advice depending on your personal circumstances. The reason it can seem like potentially poor advice is for the following reasons:

• The snowball method revolves around paying off your smallest debt first whereas mathematics proves that paying off the debt with the highest interest rate first is the most effective method. The snowball method is recommended because of the phycological benefits. I prefer a person to know the difference and choose the one that suits them best
• Paying off very low or interest-free debt is not the best use of your money. I recommend paying off high-interest debt (above 8%) as 1 step and then low-interest debt (above 3%) as a separate step.

For more information on how to tackle debt read this post

Baby Step 3 – Saving 3 to 6 months of expenses as a fully-funded emergency fund is a great step and should be undertaken. The amount can however be increased or lowered depending on your personal situation or risk profile

Baby Step 4 – Investing 15% of your household income in retirement is a great next step. Just make sure you take advantage of any workplace pension (highly recommend joining this before paying off low-interest debt)

Baby Step 5 – Saving for your children’s fund is much less of an issue for us in the UK and is not something I would factor into my financial plan

Baby Step 6 – The option of paying off your home early will be the focus of this post so I will not spoil the outcome here… please read on

Baby Step 7 – Building wealth and giving is possibly the ultimate step for most of us and hopefully everyone reading this can achieve exactly that. Whether you choose to give monetarily or with your time (once you have freedom) is your choice.

If you would like to know more about my detailed steps to wealth then please read the following blog post:

How to go From Broke to Financial Independence: 12 Steps that Anyone Can Follow

So for those of you wanting to read on you can expect to learn the following:

• How does early mortgage repayment work?
• The benefits of early mortgage repayments
• The risks of early mortgage repayments
• The benefits of not overpaying your mortgage
• The risks of not overpaying your mortgage
• Should you ever increase your mortgage?
• Do I overpay my mortgage?
• Direct comparison of overpaying mortgage or not
• Conclusion

Before we get started and for anyone who is not aware a mortgage is a loan from a bank that can only be used to buy a house. Key points regarding a mortgage are:

• They usually have a 15-40 year length of repayment (sometimes less if you are older)
• The interest rate is very low compared to other loans (car, credit card etc.)
• The interest rate is usually X amount above the Bank of England interest rate
• A mortgage is either fixed for a period of time or is flexible
  • Fixed – You will repay a guaranteed interest rate for the first years, E.g. two, three, or five years.
  • Flexible – You will pay X amount over the bank of interest rate. E.g. 2% above
• The Bank of England rate is currently 0.25% (historically low although increased from 0.1% in December 2021)
• If you have a fixed interest rate mortgage this can be remortgaged (renegotiated) at the end of your fixed term with no penalty
• If you remortgage before your fixed period is over you will receive an early repayment fee (often a percentage of the loan). The percentage usually decreases the closer to the end of the term you are

How does early mortgage repayment work?

Mortgages are loan agreements used to buy a house and therefore the agreement comes with a timeframe in which all repayments must be made. There are therefore two methods in which a mortgage can be repaid early:

• Shorter mortgage term – This is pretty simple in the fact that you choose to and agree to complete all of your repayments in a shorter term. E.g. Choose to repay the £200,000 loan in 15 years instead of 40 years (the usual maximum time).
• Overpay a longer-term mortgage – Usually, you can pay an additional 10% of the value of your mortgage each year without incurring fees (but always check your personal conditions).

Using either of the above methods will ensure that your repayments are completed in a much shorter amount of time. The catch? You may pay more each month.

What are the benefits of early mortgage repayments?

The real benefit of repaying a mortgage in a shorter period of time is pretty simple:

Your total repayments are much lower than if you had repaid over a longer period of time

Let’s look at a very real example of John and Jane Doe who have borrowed £200,000 for their family house. For this example, we will use an average interest rate of 3% over the term of the mortgage (higher than it is now but rates may change). They would repay the following:

• 10 Year mortgage = Total of £231,730
• 15 Year mortgage = Total of £248,584
• 20 Year Mortgage = Total of £266,170
• 25 Year Mortgage = Total of £284,479
• 30 Year Mortgage = Total of £303,496
• 35 Year Mortgage = Total of £323,202
• 40 Year Mortgage = Total of £343,580

Although the above is a large benefit there are others which include:

Less vulnerable to interest rate increases

In the event that the Bank of England increase their interest rate all mortgage rates will also increase (after your fixed term deal ends). By repaying early you will have a smaller balance meaning you will be less affected

Access to better future rates

Your loan to value percentage (% of the house the bank owns) will affect the interest rate you are offered when you next come to remortgage. Those who have repaid more and have a lower loan to value percentage can expect to be offered lower interest rates. E.g. 2.47% (90% loan to value) vs 1.44% (40% loan to value) – both are on a 5 year fix from Nationwide. Once you own more than 40% of the property the interest rate will change very little

Psychological benefits

Knowing that you own more of the house which provides you and your family’s shelter gives much greater peace of mind and can minimise stress and worry.

Less at risk of a housing market collapse

If house prices drop you have less risk of being in negative equity (owing more than the house is worth). E.g. you have a 90% loan to value mortgage but the house value then drops by 30%. E.g. You owe £180,000 on a house which cost you £200,000 but is now worth only £140,000 – banks don’t like that…

What we can see from the above list of benefits is that repaying early is great, as, amongst other benefits, you can potentially save hundreds of thousands of pounds. Therefore this is clearly something that we should all strive for it? Well not exactly… read on to find out what the downsides are.

What are the risks and downsides of early mortgage repayments?

Isaac Newton’s third law states:

For every action, there is an equal and opposite reaction

Isaac Netwon

Knowing this it’s critical that we should dig deeper into what the consequences and downsides are of early mortgage repayment as there are definitely some.

Increased monthly payment

In order to repay a mortgage in a shorter period of time, it requires the borrower to have higher monthly repayment amounts. Using the example from the last section (borrowing £200,000) we can see the following:

• 10 Year mortgage = £1931 a month (Total of £231,730)
• 15 Year mortgage = £1381 a month (Total of £248,584)
• 20 Year Mortgage = £1109 a month (Total of £266,170)
• 25 Year Mortgage = £948 a month (Total of £284,479)
• 30 Year Mortgage = £843 a month (Total of £303,496)
• 35 Year Mortgage = £770 a month (Total of £323,202)
• 40 Year Mortgage = £716 a month (Total of £343,580)

For the majority of us, it is unlikely that we would be able to cut the lengths of our mortgages greatly because the extra monthly payments would impact on our ability to both survive and have fun. There’s a reason mortgages generally have such long terms after all.

Lack of liquid assets if misfortune occurs

By overpaying your mortgage it is likely that you will be funnelling the majority of your money into your house and therefore this is where the significant portion (if not all) of your net worth will reside. This may not often be a problem but once the money has been used to pay your mortgage you can no longer access it easily and quickly. This can have negative effects such as:

• Interest rates have risen (and you are on a tracker or near the end of your fixed term) and very soon you will be unable to afford the new monthly rate
• You or your partner lose your job/income and can’t afford the repayments
• You are self-employed or earn a commission – by signing up for a shorter mortgage you put stress on your ability to repay during poor months

Having a lack of liquid assets means that it is much harder to deal with any misfortunes that come your way. If you had the extra money available (instead of overpaying the bank) you would at the very least be able to buy yourself time to resolve the issues. Unfortunately, the bank rarely cares that you spent the last five years overpaying if you can’t afford your monthly costs now.

Opportunity costs

A lack of liquid assets is also the route cause of this unfavourable issue which is that without liquid assets (cash, stocks, bonds etc.) you are unable to take advantage of great potential opportunities. It may be that a once in a decade/lifetime opportunity occurs but you are unable to grasp it because all of your wealth is tied up in your house.

Some examples of these opportunities could be:

• Stock market crash – The S&P 500 lost 34% of its value in roughly a month due to the covid pandemic. If you had had £10,000 which you invested at the lows instead of overpaying your mortgage that would be worth roughly double now (Jan 2022).
• Housing market crash – In 2008 the housing market crashed heavily due to irresponsible and greedy bankers and homeowners. This meant that for those who had cash available, buy to let properties could be purchased for much more attractive prices. Whether or not you agree with the ethics of this does not stop it from being an opportunity.
• A friend/colleague has a business proposal that involves you and your specialist skills. Unfortunately having no liquid assets available means you are unable to become involved. Somebody else becomes his business partner and you miss out on making huge sums.
• The opportunity of taking a sabbatical occurs – You’ve always to backpack/travel and you could have afforded it… if you hadn’t overpaid your mortgage.

Minimises advantages of leverage

Owning property has always been seen as a great investment and this is partly due to leverage. When you buy a house using a mortgage you only own a percentage of the house but benefit 100% from any increase in price:

In the above table, you can see the difference in investment potential depending on whether you are taking advantage of leverage or not. Somebody who owns 10% of a property which doubles in value will make 10 times their initial investment. Some points to note:

• Equity, in this case, means the value of the property owned by the homeowner
• The table is created using a starting house price of £300,000
• The calculations do not take into account the fact that usually, a person would be repaying their mortgage so their equity would actually increase further than shown but the effects of leverage would decrease

In the graph below we can see a clearer example of how your return % is affected.

Prevents or reduces investments

The final point is one which we will be going into more detail later on later in the blog. This is the cost of not investing the extra money into the stock market instead of overpaying your mortgage.

What are the benefits of not overpaying your mortgage?

Now that we have gone through both the benefits and drawbacks it’s time to look at what happens if you do the opposite and maximise the time you spend repaying your mortgage. For those covered under the above section (the risks and downsides of early mortgage repayments), we will quickly recap the main points.

Additional Cash Available Each Month

Having additional cash available to you at the end of each month is the largest benefit and gives the most compelling argument for why you should not adopt the Dave Ramsay approach and repay your mortgage as quickly as possible. There are however two sides to this coin which are:

• The money saved by not repaying additional amounts is wasted and spent on material goods and items you don’t even want
• The money is invested at the end of each month and left to grow and compound.

If you do not yet have self-control and will be guilty of the first bullet point then you will likely be better off repaying your mortgage. If, however, you are going to invest the difference then read on to find out just how much this is going to affect your path to financial independence.

Below I will complete a case study to compare:

Person 1 (Blue) – Overpays their mortgage and only starts to invest in the stock market once they own their house fully

Person 2 (Red) – Pays their normal mortgage balance and invests the rest

Additional points to note:

• Both have a total of £1500 a month to spend on their mortgage and investments
• Investments will grow at a rate of 8% per year
• The mortgage Value will be £200,000
• The interest rate is 2.5%
• The mortgage term is 30 years
• An increase in house value is not factored in (both would benefit exactly the same so no value included)

When running the numbers for persons 1 and 2 the figures end up looking like this:

• Person 1 has a net worth after 30 years of £845,820… Certainly, nothing to be sniffed at
• Person 2 has a net worth of a whopping £1,258,155… Over £400k higher!

These figures have been plotted in the below graph:

From this example, we can see just how powerful investing in the stock market is compared to overpaying your mortgage… In the right circumstances.

It is critical to remember that all of the following will negatively affect the above case study for the person investing in the stock market:

• A lower return than average in their stock market investments over the 30 years
• An increase in interest rates

Opportunity Costs

By not tying up the majority of your net worth in your home you will likely have access to much more liquid assets (cash, stock, bonds, crypto etc.) and this means that you are in a position to take advantage of any opportunities. As discussed earlier these opportunities could be:

• Stock market crash
• Housing market crash (to purchase a buy to let property)
• Business opportunity
• Sabbatical opportunity
• New job opportunity

Having liquid assets mean that you could take the risk of moving to a new role without worrying about it going catastrophically wrong and being unable to repay your mortgage

Allows you to take advantage of leverage

The less of your property you own the more you can take advantage of leverage as shown in the case study in the above section and therefore the longer it takes you to repay your home the more you will benefit (but also the bigger the danger in the event of a housing market crash).

Below we can again see the effects of wealth-building that using leverage can give you.

Puts you less at risk of personal disasters

Assuming that you still own the money which you could have used to (but chose not to) overpay your mortgage you will be in a far stronger position if an emergency befalls you. By having multiple months’ worth of mortgage repayments available you are safer against:

• Job loss – you or your partner
• Medical emergency – Those of us not lucky enough to live in the UK sometimes have to pay huge amounts for healthcare
• Interest rate increase

In all of the above situations, it is far better to have a larger mortgage balance but cash/assets available as you still hold power over the bank. In the event that you had a smaller mortgage but could no longer afford your repayments for a period of time, the bank would likely repossess your house.

What are the risks of not overpaying your mortgage?

If you’ve read all of the above sections then you will have likely already been able to work out the answers to this section. However, for those of you who may have skipped to here, these are the risks of not overpaying your mortgage:

Your total repayments will be much higher – compared to if you repay early as you will be paying the interest payments for a longer period of time

• For a £200,000 Mortgage:
  • 10 Year mortgage = Total repayments of £231,730
  • 40 Year Mortgage = Total repayment of £343,580

You are more likely to waste money – When you have a shorter mortgage term you are forced to put larger amounts of money towards your property which immediately increases your net worth. If you do not choose to do this then you have additional cash in your accounts. This is cash that you may be more tempted to spend rather than invest

Interest rate increases can affect you more – If the money you have saved from not overpaying your mortgage is not available in liquid assets (because you spent it or bought another house) you are more at risk of interest rate increases. The bigger your mortgage the greater the negative effect.

Future interest rates will likely be worse – When you come to remortgage at the end of your initial term you are likely to be offered a worse interest rate compared to if you had overpaid your mortgage. This is because by paying less your loan to value percentage will be higher. Generally, the higher your loan to value rate the higher your interest rate.

Addition stresses and worries – For some getting closer and closer to paying off their home will reduce or remove additional stresses from their life. If only owning 10% of your house keeps you up at night then it may be time to start overpaying your mortgage.

More at risk of house price decreases – The less of a house you own the higher the chance that the mortgage amount becomes higher than the value of the house. This becomes a huge problem if you are forced to sell (break-up etc.)

Can be more risk-averse – Knowing that you own very little of your property may force you to become more adverse to risks… some of which may have huge upsides. This can be avoided by keeping the difference saved in liquid assets (stocks, bonds and cash)

Should you ever increase your mortgage?

Those who are happy to take additional risks in the hope of greater rewards may be reading this article and considering whether they would be better off having a larger mortgage so they can take further advantage of leverage and investing in the stock market. For those considering this there are two options:

• Remortgage with a higher loan to value amount (this may only be applicable if you are near the end of a fixed-term deal)
• Request a further advance – this is an additional loan which sits alongside your mortgage and is repaid in the same way. Further advances are useful when you are tied into a fixed-term contract but want to borrow additional funds. (Be careful that if you choose to sign up for a fixed-term further advance that the period is shorter than your original mortgage or there is no early repayment fee; you don’t want additional fees when you come to remortgage).

When you should consider borrowing more

If you are thinking about borrowing more on your mortgage then you need to consider the following:

• You are easily able to repay your current mortgage each month – If you ever struggle to make your mortgage repayments then you shouldn’t ever consider taking out more debt (unless it is to pay other high-interest debt)
• Interest rates are low – at the moment interest rates are at (or close to) historical lows and therefore it is cheap to borrow additional money
• You want to spend the money on home improvements – If you plan on spending the money to create improvements to your home. This can give you a better standard of living whilst increasing the value of your property
• You want to repay debt – if you have high-interest debt then it likely makes sense to borrow additional money against your property to pay this off
• The stock market has crashed or had a correction – If the stock market has recently crashed or had a correction and is ‘cheap’ then it may be worth increasing your mortgage and investing your money here instead
• The extra money will be held in liquid assets – If you won’t be spending the money on your property then you should be using it to purchase liquid assets. This means that you can always sell them in the future if circumstances change and you are struggling to afford your repayments.
• You are financially responsible

Two points to note are that you need to consider for what reasons your bank will allow you to borrow additional funds as unfortunately, they will often say no (if it’s not for home improvements)… However what you ask for and what you choose to spend the money on is no business of mine.

You will also need to meet their feasibility criteria as normal.

When you shouldn’t consider borrowing more

Interest rates are high – if interest rates are high then it is often better to take the guaranteed return from overpaying your mortgage compared to investing in the stock market

You want to buy material items – If you want to borrow extra money to buy material items like a car then you should rethink this plan. This is lifestyle inflation and going into debt for this means that your possessions own you instead of the other way around. Save until you can really afford it

You are financially irresponsible – if you know that you are irresponsible with money then it may be better to not borrow extra money. If you can’t trust yourself to spend it on home improvements or to invest it in the stock market then do not borrow more.

You have no plan for the money – Without a plan for the money you can as well keep to your usual mortgage payments and wait until you know what you want

If there are upcoming changes to your life – If there are potentially new factors that may affect your ability to repay then you shouldn’t be considering this until more is known

Do I overpay my mortgage?

In short… No. Due to my stage in life and the mortgage interest rates associated with the loan I have I currently see no point in overpaying.

Instead, I choose to invest any additional money in broad-based index funds like the S&P 500 or a world tracker. I am comfortable with my situation but like the following:

• Own at least 25% of my home – this I feel gives me access to some of the most competitive loans (lowest rates) whilst allowing me to feel comfortable that if housing prices drop my mortgage will not be larger than the value of my house
• Have a monthly mortgage payment which is less than 25% of my income.

In the past, I have also taken out a further advance (borrowed more money) against my house and used the cash to invest in the stock market. Before taking this out I owned around 40% of my home and afterwards just over 25%.

This however is just what I chose to do – you should base your own decisions on your personal situation and your approach to risk

Direct comparison of overpaying mortgage or not

For anyone who has skipped straight to this section, we can see a direct comparison of someone who chose to overpay their mortgage and someone who chose not to below.

Person 1 has a net worth after 30 years of £845,820… Certainly, nothing to be sniffed at
Person 2 has a net worth of a whopping £1,258,155… Over £400k higher.

For more information go to the section ‘What are the benefits of not overpaying your mortgage’

Conclusion

• How does early mortgage repayment work? – You can either:
  • Overpay monthly/yearly (usually up to an extra 10% of the existing mortgage per year)
  • Agree to a shorter-term mortgage contract (E.g. 15 years instead of 30).
• What are the benefits of early mortgage repayments?
  • Your total repayments are less
  • You’re less vulnerable to interest rate increases
  • You have access to better future interest rates
  • You will often benefit psychologically from the feeling of greater safety
  • You are less at risk of having negative equity if house prices drop (owing more than the property is worth)
• What are the risks of early mortgage repayments?
  • You will have an increased monthly repayment
  • Have a lack of liquid assets (stocks, bonds and cash)
  • Potentially miss out on opportunities which would have required the money you used to overpay
  • Minimise the advantage of leverage (from the mortgage debt)
  • Prevents or reduces your ability to make investments (e.g. stock market)
• What are the benefits of not overpaying your mortgage?
  • Have additional cash available each month
  • Can take advantage of emerging and unexpected opportunities
  • Take greater advantage of leverage
  • Put less at less risk of financial disasters (if all of your net worth is tied up in your home it is difficult to access it in an emergency.
• What are the risks of not overpaying your mortgage?
  • Total repayments will be higher
  • More likely to waste money (by having more disposable income)
  • Interest rate increases will affect you more
  • Future interest rates will likely be worse compared to someone who has overpaid their mortgage and owns a greater percentage of their home
  • Potential for additional stress and worry
  • More at risk of house price decreases – you do not want to be part of a housing market crash and end up with a loan which is more than your property is worth
  • Can make you more risk-averse in other areas – knowing that your property is nearly or fully paid off may encourage you to take greater risks in other areas which may lead to greater rewards.
• Should you ever increase your mortgage? – Those who are happy to take additional risks may decide to increase the value of their mortgage to take further advantage of leverage (and use that money to invest in the stock market or complete home improvements). To increase your mortgage you could either remortgage or take out a ‘further advance’. You could consider increasing your mortgage if:
  • You are able to easily repay your current mortgage
  • Interest rates are low
  • You want to spend the money on home improvements which will increase the value of the property
  • You want to repay debt with high-interest rates – this should only be done if the extra borrowed money will be used for this purpose. If you cannot trust yourself then do not take out additional debt as you will just compound the original problem
  • The stock market has crashed or had a correction
  • The extra ‘borrowed’ money will be held in liquid assets
• You should not consider borrowing more if:
  • You are financially irresponsible – if you have not proved that you can be trusted with debt then you should minimise your exposure to it as far as possible
  • Interest rates are high
  • You want to buy material items (car etc.)
  • You have no plan for the money
  • There are upcoming changes to your life
• Do I overpay my mortgage?
  • No, I never have and currently do not plan to
  • I am comfortable owning a minimum of 25% of my property
  • Have taken a further advance (with a cheap interest rate) in the past and used the money for house improvements and to aid my stock market investing
• Direct comparison of overpaying mortgage or not (each person with £1500 to spend on mortgage repayments and stock market investments over 30 years)
  • Person 1: £845,820 net worth – overpaid their mortgage and then invested all their money in the stock market (after the house was repaid)
  • Person 2: £1,258,155 net worth – Repaid their mortgage over 30 years and invested the rest in the stock market each month

Final Thoughts

If I’ve done my job correctly then this blog post should have given you plenty of information regarding the approach you should have when it comes to repaying your mortgage.

It is important I think that each of you realises that what is the ‘best’ choice for you will be different from the ‘best’ choice for someone else. When making your considerations you should evaluate:

• Your personal situation – are you supporting a family? Is your job secure? Would you get a redundancy package if you lose your job?
• Your risk tolerance
• Your financial situation – Is all of your net worth tied up in your property or are you diversified? Do you have more than one source of income?
• Upcoming Events – Do you have a child on the way or know of something that may make it more difficult to overpay your mortgage in the future?
• Depends on the BoE interest rate – if the Bank of England interest rate is low then your mortgage is likely cheap. It makes less sense to overpay at this time.

At the beginning of this post, I spoke about Dave Ramsay and his hard and fast rule that you must always repay your home before investing elsewhere (apart from 15% into your retirement). Hopefully, this post has proved that this ‘rule’ should only be considered a guideline and if you are financially educated it does not make sense to adhere to it at all times.

My issue with the baby steps is mainly that it does not allow for flexibility. These rules are the same for each person and this is where I believe the problems lie. If you have always struggled with debt, compulsive spending and want simplicity then they are perfect. If however, you are financially responsible and in a position of strength these will likely hold you back (although I agree with completing the initial rules of creating an emergency fund and repaying short term debt).

Personally, I believe in giving as much information and as many options to people as possible before letting them decide the path they wish to travel.

Let me know in the comments below whether you currently or plan to overpay your mortgage and the reasons why.