Over 530,000 people with £30 billion in mortgage debt hope to pay off their loans from selling their homes. And another 800,000 aren’t saving enough to repay their mortgage debts.
If you are among these people you need a red alert wake-up call. You are heading for disaster or, at the very best, poverty in your old age. In fact, the only way I reckon you could survive is by emigrating to a third world country. And the sooner you act, the less it will cost to dig yourself out of the hole you’re in.
Your home is not primarily an investment. It is somewhere to live, and you will need somewhere to live for as long as you live. Most people aim to pay off their mortgage by the time they retire so that they can live rent-free for the rest of their lives.
If you don’t pay off your mortgage, you need to adopt a savings strategy that will produce at least as much in capital as your mortgage - that’s a realistic plan for anyone with 20 years to go on their loan and I’ve explained how to do it here.
Then you’ll have the money to either pay off the loan or pay the interest on it. If you have less cash than that, then when you sell your home, you’ll only be able to afford a cheaper one, and the evidence is that people don’t in fact want to do that when they retire - they may buy a smaller home, but it’s usually a nicer one in a better area.
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Start saving now
If you bought a home with an interest-only mortgage and haven’t started a savings plan to pay it off, you should start one now. Most people can afford to save something if they make it a priority, and what that means is that you just have to decide to spend less money on other things.
It’s easy to work out what you need to save to accumulate enough to pay off your loan. But don’t worry if you start a savings plan at well below this level. The important thing is to get started. Then, as your net income improves - as it will next year if you’re in a job, thanks to falling energy and food prices - you can increase the amount you save.
If you have a £100,000 loan with a remaining term of 23 years and assume you’ll get a 7% a year return on your money, then you need to save £150 each month to accumulate enough to pay off the loan. If the remaining term is 20 years, you need to save £190 per month. The longer you leave it to start saving, the greater the amount you need to save each month. The hill just goes on getting steeper, and the sooner you start, the easier it is to climb.
But note that these savings figures are very sensitive to the actual rate of return that you earn. Say you got a return of 10% instead of 7% a year - then £100 per month would be enough to accumulate £100,000 over 23 years. That’s why I recommend you start at whatever level you can afford. In the past, savings plans have often generated returns of 10% a year or more, so it could happen again. A rate of 7% a year is a reasonable average, but any money you save in the next few years is almost certain to earn a far higher return, simply because share prices are so low at present.
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Freedom of action
The great thing about having a savings plan independent of the mortgage is that it gives you more freedom of action. For example:
• You can use some or all the capital accumulated in your savings plan to pay some of the mortgage off at any point in time. This might be just what you need in order to qualify for a cheaper mortgage and thus save on interest payments, or give you the extra ‘equity’ you need to be able to move home when you need to.
• If you pay capital off your loan on a monthly basis, you no longer have the money. If it’s in your savings plan, you do, and nobody can tell you what to do with it.
• If your savings plan performs well, you can opportunistically cash part of it in and pay off some of your loan.
Conventional mortgages too
If you have a conventional ‘capital and interest’ mortgage, I also suggest you start a savings plan rather than overpay your mortgage. If you’re paying mortgage interest at under 5.5%, this is a low rate by historical standards and over a period of 15 years or more stock market savings plans have usually delivered more than this, sometimes a lot more. I’ve recently illustrated how much better off you could be if you start a savings plan instead of overpaying your mortgage. This is a potentially rewarding strategy for anyone with 15 years or more remaining on their mortgage term.
If you don’t already have an ISA, set your savings plan up as a self-select ISA with a fund supermarket. Then you can put money into several funds at once. Include at least one ‘risky’ one like natural resources, because at some point in the next 15 years it’s very likely to have a boom and you can cash in some profits and pay off a bit of the loan.
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Important risk warning - please read
The value of your investment and the income from it can go down as well as up and you may not get back a significant proportion of your investment. Past performance is not an indication of future performance. If you are in any doubt as to the suitability of an investment, you should seek independent financial advice.
