Mortgage Overpayments Should You Make Them?
I recently received a letter from one of our Buy-to-Let (BTL) mortgage lenders. No names here, but their parent company was recently nationalised. In it, they were encouraging us FN0-240 to use the opportunity of reducing mortgage interest payments to make overpayments on our mortgage account to reduce the size of our mortgage debt. There was a nice glossy leaflet extolling the virtues of doing so.
Please be in no doubt, their interest in encouraging you and I to do this is entirely for their own commercial benefit. After all, if you as a borrower are paying mortgage interest at say 2.75%, I can't imagine why the lender should want to encourage you and other borrowers to make overpayments. Maybe it might have something to do with improving their balance sheet or, maybe, just maybe, they have worked out they can then lend the money from these overpayments to new borrowers at a lending rate of 5% to 6% and charge the new borrowers an application fee of 2.5% too. Or am I being a little too cynical?
I find the communication from the lender both very self serving and also worrying in its lack of honesty and objectivity. For many borrowers, making such overpayments could actually be very detrimental to them. Let me explain a little more;
The Benefits of making overpayment on a Buy-to-Let mortgage
1. It reduces your debt
2. It reduces the amount of interest you pay in the future
3. The lower the debt as a Percentage of the value of the property, the more likely you are to be able to re mortgage onto a competitive rate in the future, (once competitive remortgage deals reappear on the market).
4. If you are likely to need the income from the rental properties to supplement your other income to live on in the foreseeable future, reducing your mortgage will free up more of the rental income for you to use. (Though this does raise a further question as to whether maintaining and rely upon a rental portfolio through retirement is appropriate for you as an individual).
5. If a rental property is vacant at some point in the future, you will spend less from your other income servicing the debt.
The disadvantages of making overpayments.
1. A borrower can only offset the interest payments against the rental income to reduce the tax liability, NOT any capital repayment. So, any overpayments you make will result in an increase in Income Tax liability going forward.
2. Unless you are using an 'offset mortgage' any overpayments you make on your mortgage are a repayment of capital, which are no longer available to you. If you want to borrow this money again, it will be a new loan subject to the terms currently availableFN0-125 and subject to your status at the time of the application. If you find that in the future you have lost your job, your business cash flow is going through a tight patch or your sources of income are not high enough to meet your needs, you are not likely to re secure such facilities. Had you not made the overpayments and simply placed them in a deposit account, that capital would have been available to you to use, thus providing you with more breathing space until your situation improved or to give you a chance to sell a property.
3. It is highly likely that the mortgage interest rate you are paying on an existing deal is significantly lower than the rate on new deals currently available. Thus if you want capital to put toward future property purchases, (or even other purchases such as a car), you are not going to be able to secure new borrowings at the rate you currently have. Currently, most borrowers who have a deal which was secured before the onslaught of the credit crunch and has now reverted to the variable rate, is likely to be on a pay rate of between 2.5% and 3.8%. New borrowing facilities are typically starting at circa 4% yet have application fees of 3.5% and are limited to lending a maximum of 70% loan to value (LTV). If you need 75% LTV, the deals start at circa 5.3% with application fees at circa 2.5%.
The above is not intended to be an exhaustive list. Neither should it be construed as personal advice. Each individuals circumstances and needs should dictate the appropriate course FN0-100 of action.
There is another very important matter the letter from the lender does highlight. The importance of not being short sighted and simply spending the new rental income surplus in excess of the mortgage payments. There is a huge opportunity here for individuals to use this as an opportunity to save more tax and to significantly increase their long term wealth and financial security.
I would strongly urge those of you contemplating mortgage overpayments, (be they on a BTL mortgage or even on their own domestic mortgage) to seek good independent advice as to the best options for you.
Please be in no doubt, their interest in encouraging you and I to do this is entirely for their own commercial benefit. After all, if you as a borrower are paying mortgage interest at say 2.75%, I can't imagine why the lender should want to encourage you and other borrowers to make overpayments. Maybe it might have something to do with improving their balance sheet or, maybe, just maybe, they have worked out they can then lend the money from these overpayments to new borrowers at a lending rate of 5% to 6% and charge the new borrowers an application fee of 2.5% too. Or am I being a little too cynical?
I find the communication from the lender both very self serving and also worrying in its lack of honesty and objectivity. For many borrowers, making such overpayments could actually be very detrimental to them. Let me explain a little more;
The Benefits of making overpayment on a Buy-to-Let mortgage
1. It reduces your debt
2. It reduces the amount of interest you pay in the future
3. The lower the debt as a Percentage of the value of the property, the more likely you are to be able to re mortgage onto a competitive rate in the future, (once competitive remortgage deals reappear on the market).
4. If you are likely to need the income from the rental properties to supplement your other income to live on in the foreseeable future, reducing your mortgage will free up more of the rental income for you to use. (Though this does raise a further question as to whether maintaining and rely upon a rental portfolio through retirement is appropriate for you as an individual).
5. If a rental property is vacant at some point in the future, you will spend less from your other income servicing the debt.
The disadvantages of making overpayments.
1. A borrower can only offset the interest payments against the rental income to reduce the tax liability, NOT any capital repayment. So, any overpayments you make will result in an increase in Income Tax liability going forward.
2. Unless you are using an 'offset mortgage' any overpayments you make on your mortgage are a repayment of capital, which are no longer available to you. If you want to borrow this money again, it will be a new loan subject to the terms currently availableFN0-125 and subject to your status at the time of the application. If you find that in the future you have lost your job, your business cash flow is going through a tight patch or your sources of income are not high enough to meet your needs, you are not likely to re secure such facilities. Had you not made the overpayments and simply placed them in a deposit account, that capital would have been available to you to use, thus providing you with more breathing space until your situation improved or to give you a chance to sell a property.
3. It is highly likely that the mortgage interest rate you are paying on an existing deal is significantly lower than the rate on new deals currently available. Thus if you want capital to put toward future property purchases, (or even other purchases such as a car), you are not going to be able to secure new borrowings at the rate you currently have. Currently, most borrowers who have a deal which was secured before the onslaught of the credit crunch and has now reverted to the variable rate, is likely to be on a pay rate of between 2.5% and 3.8%. New borrowing facilities are typically starting at circa 4% yet have application fees of 3.5% and are limited to lending a maximum of 70% loan to value (LTV). If you need 75% LTV, the deals start at circa 5.3% with application fees at circa 2.5%.
The above is not intended to be an exhaustive list. Neither should it be construed as personal advice. Each individuals circumstances and needs should dictate the appropriate course FN0-100 of action.
There is another very important matter the letter from the lender does highlight. The importance of not being short sighted and simply spending the new rental income surplus in excess of the mortgage payments. There is a huge opportunity here for individuals to use this as an opportunity to save more tax and to significantly increase their long term wealth and financial security.
I would strongly urge those of you contemplating mortgage overpayments, (be they on a BTL mortgage or even on their own domestic mortgage) to seek good independent advice as to the best options for you.
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