How To Tame The Mortgage Beast

Buffeted by a barrage of bad news , it becomes quite difficult to see the opportunities that are out there, waiting to be discovered. Granted we are in the midst of the worst financial crisis in living memory, millions are losing their jobs , millions are losing their homes ... But those homeowners, who have managed to hold on to their jobs, have been presented with a historic window of opportunity to do themselves and their families some long term good ... i.e lighten the burden imposed by the mortgage monster... substantially!!

First we need to indulge in some myth-busting. Have you heard people say that interest payments in a repayment mortgage tend to be front loaded - i.e you pay interest before you start paying off the capital - so, even after a few years of repaying the mortgage, you still owe the bank almost as much as you did, when you took on the mortgage. My mortgage advisor told me this : "Even after 6-7 years of repayment , you will have paid back very little of the outstanding loan, because interest payments are front loaded." I did some research on the subject and found that she was wrong !!! Yes the professionals are not always right. The mathematics of mortgage repayment is structured in such a way , that you repay very little capital in the first few years , when the interest rates are very high and only when the interest rates are very high. What is described as front loading only happens in times when interest rates are high. It happened when the Tories were in power and people discovered 'front loading' , many were scarred for life when they saw they had repaid very little capital even after years of repayment.... and the term 'Front Loading' stuck in the minds of a generation. But in this era of low interest rates 'front loading' as it is understood , does not happen.

To illustrate the effect of interest on capital repayment , consider the following :
Someone on a repayment mortgage, with an interest rate of 10%, will have repaid less than 1% of the outstanding loan , after one year . If the interest rate were 5%, they will have repaid more than 2% of the loan after one year. If the rate were 2%, they will have repaid more than 3% after one year. If the BOE rate goes to zero , the lucky chaps on the Woolwich's BBR+0.19% tracker mortgage (of the repayment variety) , will have repaid more than 3.9% of the loan after year one !!!

Consider the fact that the Bank Of England's interest rate is at a historic low , consider also the mathematics of mortgage repayments and you will see what I am getting at. For purposes of illustration let us consider a homeowner on a 100k , repayment tracker mortgage at BOE+0.99%. After one year, she would have paid back 2.9% of the original loan (£2920). BOE rate was 5.75 not very long ago , it is now 1.5% - so from peak to trough her monthly mortgage amount would have gone down by at least £240. So that means she would need to pay £2880 less per annum now. If our homeowner uses this extra cash, £2880, to repay capital, by the end of the year she would have repaid £5800 (=2920+2880). So at the end of year one, she only owes £94200. If she repeats this process again year after year, she will find that the amount owed starts going down dramatically and she can be mortgage free at least 10 years earlier than originally planned. This ,of course , assuming interest rates don't go up. In the near term, they are more likely to go down than up. But even if they do go up after some time, as they inevitably will, with all the extra payments made, our homeowner would still owe a lot less and be better placed to weather future financial storms. Alternatively, she could squirrel away the £ 2880 saved per annum into a high interest savings account (net rate needs to be higher than the mortgage rate). If the mortgage rates go up she could use this cash pile to make lumpsum capital repayments , thereby reducing the outstanding loan and the monthly mortgage amount.

In a nutshell , chip away at your mortgage as usual , with the normal monthly repayments. Save the extra cash freed up due to low interest rates and use them to make lumpsum repayments of capital. Slowly, but surely you begin to take the edge off your mortgage and before you realize it , you will have rendered the mortgage beast toothless - powerless to do lasting damage to your financial well being. An unfortunate set of circumstances have conspired with human greed, folly & fear and have brought us to this point. This has now resulted in the lowest rates in 300 years. All you need to do is sieze this opportunity and slay the mortgage beast or tame it at the very least !!!


Jay