Shocking as it may seem, there may come a day where your mortgage repayments no longer seem like the gigantic monsters they are now.
For most, this comes about as their careers advance and wages rise. It could also happen as they spend less on frivolous items, like cigarettes and alcohol, than they did in their late twenties.
The problem is that no house-buyer has a crystal ball when they take out the mortgage. This means that they often borrow over a longer term than they need to, in an effort to minimise initial mortgage repayments. And then, a few years on, find themselves with a loan that no longer suits their financial circumstances.
The longer term will have made sense at the start, at least from a budgeting perspective, since it will allow the new home-owner more freedom with their finances at an uncertain time. The benefit of longer terms is simple - the period over which you repay the loan is extended, thus reducing the amount you need to pay back each month.
Thus, a €250,000 loan at 3.1 per cent over 20 years will carry monthly net payments of about €1,300 for a first-time buyer. The same loan over 30 years would however carry repayments of €1,000, thus freeing up €300 each month for other expenses.
Given that our buyer may not need this extra cash in a few years time, it may make sense to think about how they could rework their mortgage at that stage.
This kind of approach makes sense when the mortgage-holder considers how much their longer term is costing them in additional interest payments. Based on an unchanged interest rate, the 20-year loan will, over its lifetime, cost about €85,000 in interest. The interest on the 30-year loan will be a whopping €134,000. Suddenly, the idea of shortening the term seems like a very good idea indeed. The next step will be achieving it.
There are two clear routes to reducing a mortgage's term after it has commenced. Provided the loan is at a variable rate, the customer can either cut the overall term by paying off a lump sum or by overpaying by a fixed amount each month. In this way, an additional €200 repayment each month would reduce the above 30-year mortgage to 23 years.
Likewise, a €20,000 lump-sum overpayment in the fifth year will cut about three years off the 30-year term. And thus that extra disposable income has been put to work.
It will be worth remembering that the business of using spare cash to lessen the mortgage burden does not even have to be conducted in such a structured way. For some consumers, it may be more practical to take out First Active's current-account mortgage - a product that essentially combines a customer's current account with their mortgage account and allows cash in the former to reduce the interest due on the latter. In this way, borrowers can introduce their own kind of flexibility to their finances.
Above all of this is the basic financial principle that money must be invested where it can achieve the maximum return. From this perspective, a mortgage overpayment may not seem like the best option since it essentially only delivers a return of 3.1 per cent - the amount the loan would have cost if it had been maintained in full. What this principle does not take into account however is the peace of mind factor, or the sense of calm that a lower mortgage can deliver.
