There are three key things that I believe made our dream of mortgage freedom a reality. We became mortgage free in July 2016 after working towards our goal for almost five and a half years.
It wasn’t easy and it wasn’t just 3 things that got us there- there are lots of smaller things we did to manage our money better every day, week, month and year.
This absolutely isn’t intended as advice, and you should make sure you understand the consequences of any financial decisions you decide to make. Hopefully, though, this will give food for thought anyone else seeking mortgage freedom.
I understood the impact of overpayments before I had a mortgage because of one of my early jobs in a call centre. You can get this same knowledge from one of the various mortgage calculators there are online. I’ve used this one at Money Saving Expert quite a lot over the years. That’s what I’ve used to re-run the figures below.
It was back when the Bank of England base rate was 5% meaning that mortgage rates were in the region of 7%. I plugged some figures into a calculator and worked out that a mortgage of £100k over 25 years at 7% would have had a monthly repayment of over £700. The total amount repaid would be £212k, more than double the amount borrowed!!
I saw that if I overpaid by £50, that would cut the interest bill by £20k and knock nearly 4 years off the term. £50 a month seemed a lot on top of £700.
But even £5 per month would knock 5 months off the term and save nearly £2,500 in interest.
Or if I could scrape together £1,000 after a year of holding the mortgage to make as a capital payment, it would save £4,500 in interest over the life of the mortgage.
By the time I got a mortgage, bank base rate was 0.5%. It seemed a no brainer to choose a house well within our affordability and then set our monthly payments at £700 per month, far above the minimum payment required.
Of course, the amount you save in interest won’t be as high at the moment but that’s because interest rates are much lower. Hopefully that means you have more spare cash to overpay with (or actively choose to do something else sensible with!)
2. Choosing a variable rate mortgage
I don’t know why, but the UK is in love with fixed rate mortgages and there are loads more fixed rate options out there. Without a doubt, they give certainty of payments over the period of time that the rate is fixed for. If knowing your exact mortgage payment for the next 2, 3 or 5 years is important to the success of your budget, then it might be for you. My complaint about them is that they restrict you in the amount of overpayments you can make before you start incurring charges (and, crucially that can restrict your mindset).
We started out with a low minimum monthly payment by choosing a 30 year mortgage (5 years longer than what has traditionally been considered a ‘normal’ mortgage term). It might seem counter intuitive for someone aiming to be mortgage free, but in the event either of us lost our job, it would make it easier to manage until the other found employment. However, with no early repayment charges, the variable rate mortgage meant we could significantly reduce our term by consistently overpaying without being penalised.
A variable rate mortgage isn’t for everyone and it does come with uncertainty. However, if you’re committed to making overpayments, the risk of your payment going up is reduced because if your monthly payment were to be recalculated, it would most likely reduce (even though you would still be being charged more interest on the balance that’s left).
One luxury we hadn’t foreseen with a variable rate mortgage was the ability to pounce on a competitive tracker rate when our LTV (loan to value) came under 60%, allowing us to move swiftly and benefit from an even lower variable rate.
I’ve read that many people get around the ERC (early repayment charge) on a fixed rate mortgage by saving in a separate account and make a lump sum payment when the year ‘resets’. If this works for you, that’s brilliant. We thought seeing a positive savings balance was likely to make us feel like we were doing really well and therefore be less focussed on driving that balance up as much as we could. I was also concerned that I wouldn’t want to pay all the money saved to the mortgage because it would feel like whipping away part of your security cushion… What if we might need it?! Whereas once its paid, its paid and was never part of your cushion anyway.
3. We set ourselves an annual balance reduction target
When we first did this, we didn’t intend to do it through the life of the mortgage.
The idea was that we’d hammer the mortgae in year one, because we’d psyched ourselves up for tightening out belts anyway and we would then benefit from having a lower balance on which interest is charged for the life of the mortgage.
However, as certain expenses reduce (insurance, for example) and income crept up, we maintained or increased our target year after year. Most years we fell slightly short and do you know what? We celebrated! Because without the target, we would have come nowhere close.
Why a balance reduction target rather than an overpayment target?
- Making £10k in overpayments reduces the balance by less than £10k, so balance reduction target stretched us further than an overpayment target would have done.
- In working out how much we would need to pay, we calculated the annual interest based on the balance at the start of the year. This would reduce with each month of overpayments, but in effect made our target easier to reach because we had background assumptions of greater values needing to be made.
- We aimed to get the amount of annual interest paid as close to the start of the year as possible, so every subsequent payment would count towards reducing the balance
And that’s it, the 3 key things that made the difference for us. Except that’s not quite it. As I said before, lots of other things were done daily, weekly and monthly. I’ll tell you more in my future posts….
If you have examples of big things that made the difference to your financial goals, I’d love to hear about them! And what about big ideas that didn’t go so well?