How to… overpay your mortgage
There are different ways of overpaying on your mortgage. You can simply increase your monthly payment, you can use an offset mortgage, or you can pay your mortgage weekly rather than monthly, effectively getting an extra month’s payment in over the course of a year (13 payments instead of 12). The latter system is one I think works particularly well.
I’d encourage you to set up weekly payments so that you are paying ‘in advance’: if your January mortgage payment is due on the 31st, then on the 7th January you should arrange to pay one-quarter of your regular monthly mortgage payment; and the same again on the 14th, 21st and 28th. This way you’ve paid the amount due three days early, and over the course of the year that will see you make 13 months’ worth of payment instead of 12, without really noticing the extra money leaving your account as it’s part of your regular spending (see my bank accounts system here).
Offset mortgages come in two broad varieties. The first is a general offsetting account, where your interest is calculated based on your mortgage minus any linked savings account(s) you hold; if you have a £250,000 mortgage and £50,000 in savings, you’ll only pay interest on the £200,000 difference. Note that you won’t earn any interest on your savings balance.
The second is a current account offset mortgage, which I don’t like as much because everything’s in one pot. In this scenario, if you have a £100,000 mortgage, you effectively have a £100,000 overdraft instead. When your salary goes in on the 1st of the month, your mortgage is reduced by that amount. If you can arrange for your bills to come out at the very end of the month, you’re ‘keeping’ your money for an extra 30 days or so.
There are advisers out there that favour this arrangement, but for me it’s too risky in respect of access to too much money – you can spend right up to your £100,000 limit, so unless you’re very disciplined with money I don’t recommend this arrangement.
The 40/40/20 snowball system
Should you overpay your mortgage rather than invest? I describe the difference between your income and your expenditure each month as your snowball, your surplus money. I recommend you split that snowball 40/40/20 – 40% goes on your retirement savings, 40% on your debt overpayments, and 20% is for fun.
This way you get the best of all worlds. By investing, you have the psychological effect of becoming wealthier, better with money and feeling like you’re building security. By paying debts (including your mortgage) down quicker, you get the certainty of improvement – regardless of investment or stock market performance, you have a guaranteed return of increasing your net worth. And by paying yourself 20% you’re living for today, not for an event that’s going to happen in the future (like your retirement). That’s important because of the stages we go through in our life, which I discuss below.
Once you reach the glorious day of your mortgage being paid off, you reassess how you allocate that 40% of your surplus. Are you on track, or playing catch up, when it comes to your future plans? If you’re on track, then simply split what was your mortgage payment between investing and your ‘fun’ money. If you’re playing catch-up, you may have to take the entire 40% and put it into your retirement planning.
I believe we have chapters in our lives where we move from one defining period to another. Everyone’s periods are unique depending on their life decisions, and they can be micro-level (a year or two in each period, so life has many ‘chapters’), or larger periods. On the larger scale, I feel we all have three main chapters in our life:
- Childhood (birth to 21)
- Adulthood or working life (21 to 66)
- Retirement (66 to our final days)
And obviously within these chapters there are many smaller defining periods. Once we are a young adult, say 21, we have approximately 45 years before we retire – bear with me, I appreciate we are all individual. Actuarially we may live to 88, so 45 years working is approximately 50% of our life on this wonderful planet.
So, our life can broadly be split into:
- Childhood – 25%
- Adulthood – 50%
- Retirement – 25%
If we use all our childhood to prepare for our adulthood, and if we use all our adulthood to make our retirement fun, we’re missing 50%–75% of our life. Why am I telling you this? Because in my 20-plus years as a financial planner, I have seen hundreds of clients planning for retirement as if adulthood is a preparation ground. It’s not. It’s all called life, and we need to ensure we are extracting the juice from it.