A shock slump in mortgage debt

by Cliff D'Arcy on 03 July 2012  |  7 comments
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In May, mortgage debt fell for the first time since 1997. You could join this repayment revolution!

Something very, very unusual happened last month. In May, UK mortgage debt went down from one month to the next. 

What this means is that Britain's 11.3 million mortgage borrowers paid back more than banks lent to new borrowers. For the record, this is the first time that repayments have exceeded the amount being lent since month-by-month records began in 1997. 

According to the British Bankers' Association (BBA), mortgage approvals in May were the lowest for more than a year. They fell by over 3% to 30,238, while net mortgage lending dipped by £73 million from April. In other words, existing borrowers repaid £73 million more than borrowers took on in new debt in May. 

Up, up and away 

This is surprising because, ever since the last housing boom started in 1995, UK mortgage debt has been rising relentlessly. Here's how it has soared over the past two decades: 

Source: Bank of England, Lending to Individuals, VTZK 

Join the repayment revolution! 

When I ask British adults about their financial dreams, the most common reply is "To be out of debt and mortgage-free". So I'm delighted that more and more of Brits are realising this dream by reducing their mortgage debt and are on the way to owning their own homes, free of banks and building societies at last. 

What are the best ways for you to jump aboard this repayment bandwagon? Obviously, the first question to answer is whether it makes sense for you to reduce your mortgage, instead of repaying more expensive debts or saving. 

For example, there's not much point reducing your mortgage if you're paying an interest rate of only, say, 2% a year. It would make much more sense to earn 3% a year tax-free inside a top-paying cash ISA. 

Therefore, the first thing to check is whether you can make more money by saving (or repaying credit cards and other expensive borrowing), rather than making inroads into your mortgage. 

If you’re clear that paying down your mortgage is the best way to use your spare cash, then you need to decide how to overpay. In essence, you have four options: 

1.   Be flexible 

If you have a flexible or 'offset' mortgage, then your contract allows you to make overpayments and underpayments at will, subject to generous limits. In this case, you can drop cash into your mortgage account whenever and however you choose. 

For example, you could set up a monthly standing order for an extra, say, £50, or ask your mortgage lender to bump up your usual direct debit to a higher amount. Likewise, you could use cash or cheques to knock extra sums off your mortgage. 

In addition, flexible mortgages calculate interest daily, so they reduce both your debt and your future interest bill from day one. That's why it can make sense to overpay as much as you can as early as you can. This will kill off your home loan that much faster. 

2.   Make a lump-sum repayment 

Whatever type of mortgage you have -- repayment or interest-only, flexible or traditional -- you should be able to make a lump-sum repayment against your loan. 

In many cases, you can drop in one-off sums as and when you like. However, there may be upper or lower limits on how much you can repay in one year, say, 10% of your outstanding balance, so always check before lobbing money into your loan. 

Also, you may be unlucky enough to have a 'yearly rest' loan, which means that your repayments are knocked off your mortgage debt only on 31 December or another pre-set date, such as 31 March. 

Clearly, the best time to make overpayments towards these loans is just before this key date. Then again, do allow yourself up to two weeks for any overpayments to be processed. The last thing you want is to miss the cut-off date and, in effect, give your bank an interest-free loan for nearly a year. 

3.   Make monthly overpayments 

If you have a flexible mortgage, or a loan that calculates interest daily or monthly, then setting up a monthly overpayment is a smart move. 

To do this, you could create a standing order for an extra, say, £100 a month, to be paid on top of your usual monthly repayments. Alternatively, you could ask your lender to raise your monthly direct debit by an additional amount or to a higher level (such as rounding it off to the next £100). 

4.   Shorten your loan term 

Your fourth option is to reduce the term -- shorten the life -- of your loan, but this works only if you have a repayment mortgage. 

For instance, let's say your existing mortgage has 22 years to run. By cutting this to, say, 17 years, you will slice five years from the life of your loan. While this will significantly increase your monthly repayments, it will also slash many thousands of pounds from your future interest bill. 

5.   Watch out for penalties 

To kill off your mortgage as fast as possible, you need to avoid any repayment penalties. 

Therefore, before deciding on any over-payment plan, check with your lender to see what charges it can levy. If you have a fixed, discounted or low-rate deal, then there are sure to be restrictions on how much or how little you can repay, and when. 

In short, please make sure you build your mortgage-free plan around these limitations, otherwise you could lose out on the full benefit of over-paying. 

Lastly, good luck with hitting your goal of being mortgage-free! 

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