Published On: Mon, May 13th, 2024
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Worried you won’t clear your mortgage before you retire? Here’s how to do it | Personal Finance | Finance

The under-30s are taking out home loans with terms of 35, 40 or even 45 years, stretching into retirement and beyond. They don’t want to do this, it’s the only way to make repayments affordable. However, it could cause them severe financial problems further down the line.

Anybody who fails to clear their mortgage by the time they retire is in trouble. At that point, their income is likely to drop, making servicing their debt even harder.

Instead of shrinking, the debt could start rising again. It’s a terrifying prospect.

Especially since young people are also struggling to build enough retirement savings, while the state pension may come under increased pressure.

This bleak scenario emerged from a Freedom of Information (FoI) request made by former pensions minister Sir Steve Webb, now partner at pensions consultancy LCP.

Webb said: “The challenge of getting on the housing ladder is forcing large numbers of young home buyers to gamble with their retirement prospects by taking on ultra-long mortgages.”

Many could be forced to use their retirement savings to clear the debt, leaving them short of money to fund everyday living costs, he added.

They face a greater risk of falling into poverty in old age.

Back in the day, the average mortgage had a 25-year term. Somebody buying at age 30 or 35 had a good chance of clearing the debt by the time they reached retirement age.

Now the task is getting harder, as wages stagnate while house prices continue to climb.

First-time buyers get on the housing ladder later in life, have to borrow more to afford somewhere decent, and repay it over a longer term.

While extending your mortgage term can cut repayments in the longer short term, it means paying more overall.

Somebody borrowing £250,000 over 25-year term will pay £1,461 a month, based on a repayment mortgage charging five percent a year.

If they took out exactly the same deal but stretched the term to 35 years, their repayments would drop to £1,262. That’s a saving of £199 a month.

This could be the difference between buying and not, but there’s a catch. The buyer will be repaying this mortgage for an additional 10 years. This will increase their total capital and interest repayment over the term from £438,443 to £529,922.

The 35-year mortgage will cost them an extra £91,479.

That’s a staggering additional sum. It’s more than £9,000 for each year they stretched their repayment term.

The good news is that there are things you can do to bring this bill down.

One option is to shorten your mortgage term a few years down the line, when you’ve got cash to spare.

Another is to make mortgage overpayments.

I’m a huge fan of mortgage overpayments. Most mortgages now allow borrowers to overpay 10 percent of their loan each year, instantly shrinking the cost.

In my second example, a buyer who chose the 35-year term but made a modest regular £100 monthly overpayment would clear their debt almost six years early.

After 29 years and one month, to be precise.

They would slash their total repayment from £529,922 to £474,216. That would save them a hefty £55,706.

The more they overpaid, the more they’d save and the sooner they’d be mortgage free.

Similarly, someone who made a one-off lump sum overpayment of £10,000 would slash their term from 35 years to 31 years and seven months, and save £42,619 in total. That’s more than four times the sum they overpaid.

It’s a brilliant way getting mortgage debt under control.

Here’s another positive. The Bank of England is likely to start cutting interest rates at some point this year. It will cut even more next year.

When that happens, mortgage rates will fall, possibly quite sharply. At that point, buyers who are free to remortgage could grab a cheaper rate AND shorten their term at the same time.

Their monthly repayments may not even increase.

The ultra-long mortgage term is a trap. But there are ways of breaking out of it, provided you take them.

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