Should I clear off my mortgage? – Limerick financial planner examines pros and cons

This week I’m going to share with you two questions that I received recently from people who were asking the same question i.e. should they pay off their mortgage early, but the answers to both were different because their circumstances were different.

Question
Liam, I’ve inherited a sum of money that’s enough to clear off my mortgage and I’m wondering should I? My husband and I are both 35 years old and we’re five years into a 30 year mortgage where we originally took out a mortgage of €350,000. We have a variable rate mortgage of 3.5%. I’ve been told different things by family and friends and I’m not sure what to do. Some are saying not to because it’s the cheapest loan you’ll ever have and someone else said why clear it when there is a life policy in place that would clear it if anything ever happened to me or my husband. Others are saying clear it and you can earn less and if you ever lost your job or became ill, no one could take your house off you. Lots of different opinions and I’m confused and not sure what to do so if you could help it would be great. Thanks Liam

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Answer
Like you I’ve often heard the, don’t pay off your mortgage argument from people as well. And it comes from non-financial advisers and some financial advisers say it as well, but in my opinion you can’t just blandly say no one should ever pay their mortgage off early without knowing more about people’s individual circumstances.
Because some people might want to pay it off early because it allows them to earn less and that’s important to them and others want to pay as little interest to banks as possible and there are others that want to be mortgage free for no other reason than it makes them feel better and it gives them huge peace of mind and that’s fine as well, nothing wrong with that.
Okay, let’s look at the reasons people put forward as to why you shouldn’t clear off a mortgage.
And there are typically two with the first being that your mortgage is the cheapest loan you’ll ever have and why pay off such a cheap loan? And they’re not wrong and that’s because of the interest rate charged against a mortgage. It’s likely to be lower than personal loans, car loans, credit cards, overdrafts and so on.
Having said that, even though the rate is low a mortgage is going to cost you the most in interest payments and that’s because of the term of a mortgage which in Ireland is on average about 30 years.
So, if we look at your mortgage, what seems like a small rate of 3.5%, will end up costing you €215,796 in interest payments over 30 years assuming the rate averages out at 3.5% over that time period.
You borrowed €350,000 but you’d end up paying back the bank, €565,796.
Not such a cheap loan after all is it? And this end number is often lost. Which is why you can’t just say it’s the cheapest loan you’ll ever have without commenting on how much the small rate will end up costing you.
And you are five years into your mortgage and have you any idea how much interest you’ve paid already?
If you know well done and if you don’t, the answer is €58,239.
You’ve made repayments over the past five years amounting to €94,300 but of that amount, only €36,061 has reduced the amount you owe.
I digress a little but important to point this out to you.
The second reason people are being advised not to pay off their mortgage early is, because they have a life assurance policy in place and if anything happened to them i.e. they or their spouse died, the life policy would pay off their mortgage so they should keep the inheritance money and do something else with it.
But what if they don’t die?
Hopefully they will be alive long after their mortgage is repaid. And if that’s the case they’ll have paid a fortune in interest payments not to mind life assurance premiums.
I personally think this is a very weak argument but let me appease those who aren’t for moving in this instance and show them (a) how they can pay off their mortgage and save a tonne in interest payments and (b) still get a payout should one of them died even if they didn’t have a mortgage anymore.
And let’s take your mortgage as an example.
We know that if your current mortgage runs to term you will pay back €215,796 in interest payments (cheapest loan you’ll ever have, yeah right) but if you clear it now you’ll save €157,557 in interest payments. Remember the first five years you’ve made interest payments of €58,239 and that’s money you’re not getting back.
And if you don’t clear off your mortgage and live for the next 25 years you’ll end up paying an additional €7,569 in mortgage protection premiums.
So, if you don’t clear your mortgage and you both live for the next 25 years, it was a bad decision and if one of you doesn’t, then it was a good decision and the life assurance premiums were great value and worth keeping.
But who knows when they will die?
So, how do you clear the mortgage and save all those interest payments whilst you or your family will get all of that money back should one of you die?
And the answer is by exercising what’s called a continuation option on your existing mortgage protection (life policy) plan which allows you to convert your existing policy to a guaranteed term protection.
This allows you to keep life cover in place for €314,000 which is about how much you owe now on a level basis (the amount of cover stays the same) under a new plan.
The cost of this new policy would be fixed at €43.19 per month.
Using the strategy, you would clear your mortgage and save €157,557 in interest payments.
You would then take out a new term assurance policy in the amount of €314,000 and should either one of you pass away in the next 25 years, the surviving person will get that €314,000 back.
If you follow this route you might feel better that you have saved €157,557 in mortgage interest payments and should one of you God forbid pass away and hopefully neither of you will, €314,000 will be returned to the surviving person.
And if both of you live for the next 25 years, that new life assurance policy will have only cost you €12,957 which is a whole lot less than €157,557!

Question
Liam, I’ve received a redundancy payment that is large enough to clear off my mortgage and I’ve made up my mind that I want to pay it off. However, I’m currently on a fixed rate and the penalty for paying it off early is about €4,000. I have about two years left on my fixed rate so should I pay it off anyway or wait until the fixed rate is up in two years and then pay if off?

Answer
I couldn’t answer the question properly without getting more information from this person i.e. how much did they initially borrow, what was the interest rate, when did they take out the mortgage, what term was left to run etc.
And once I knew these answers, my reply was as follows:
If you keep your mortgage in place for the next two years, the amount of interest you’ll pay over those two years will be €10,214.
So, it doesn’t make sense to wait for those two years because you’ll end up paying more in interest than what the penalty is costing you.
If you’d pay less in interest repayments than the penalty amount then for sure you’d wait the two years before clearing your mortgage but in your instance it’s not the case.
And you should have the mindset that clearing your mortgage now isn’t going to cost you €4,000, but rather you’re actually saving yourself €6,214.

Liam Croke is MD of Harmonics Financial Ltd, based in Plassey. He can be contacted at liam@harmonics.ie