Following on from Conor Popes article in the Irish times yesterday http://www.irishtimes.com/newspaper/pricewatch/2011/0404/1224293731588.html and subsequent article today, I have been receiving calls regularly from clients asking should they do it.
The article basically advises that if you make mortgage repayments more than once a month, because interest is calcualted daily you can save signifciant money in interest.
I was glad to see Conor highlight today that the real savings actually come from making extra payments annually. http://www.irishtimes.com/newspaper/ireland/2011/0405/1224293869088.html
When I worked the figures out for one client this is what I came up with. I also advised on an alternative to making extra payments to your lender:
This client has a mortgage of €404,800 at a fixed rate of 3.19% over a 27 year term. For the purposes of this calculation I have just assumed the rate will remain the same for the whole loan term. If he continues to pay the mortgage repayments of €1865.29 for the 27 years (324 monthly payments) he will pay total payments of €605,326. If we take away the original loan amount of €404,800 he pays total interest of €200,525.
If he decides to pay twice monthly his total interest reduces to €199,149 saving him €1,376 over the term of his loan.
However as mentioned if he starts to pay every second week he will make 26 payments of €932.64 per annum meaning he will only have to make a total of 620.16 payments reducing his mortgage term and thus saving him €26,942 or 13% off his interest bill.
My piece of advice is slightly different however. For most people paying the bank more than what they are expecting isn’t always the right thing to do. This is for several reasons:
- Lots of peoples don’t have a “war chest”. This is money they can dip into in an emergency. By not accelerating your payments you can build up your war chest.
- If the extra payment is invested and you get a better interest rate on the investment that you pay on your mortgage it will make financial sense.
- Once the money goes into the mortgage in most instances you will have to re-mortgage to get it back again. It’s unlikely that if you need to remortgage to get your “extra” payments back that you won’t meet the lending criteria.
- You can always use the savings to clear the loan early if you want, but you may want to do something else with it.
- By saving separately it leaves more options open to you.
If my client in this instance were to save the “extra” repayment assuming 6% growth and after taxes and charges after 27 years the savings fund would be worth €96,881. This in my opinion for most people is the better option.
Every case is individual so get good independent financial advice.