First-time buyers, on the whole, are taking out longer mortgages as they attempt to manage affordability concerns – yet there are some are bucking the trend in a bid to cut down future debt.
Those buying their initial homes take on average loans of 31 years, according to UK Finance data, up from 28 years a decade ago.
The logic is simple. Longer mortgages cut monthly payments, as the debt is repaid over a longer period.
But there is, of course, a downside. Extending mortgages means paying greater amounts overall – as you accrue more interest – while you end up not becoming debt-free until later in life.
It’s why a small number of buyers are doing the reverse, and taking out short mortgages of 20 years or less. If you buy before you are 30, this sort of mortgage can mean you are a debt-free before you turn 50.
However, this does come at a cost. Your mortgage payments will likely be hundreds of pounds more each month on a typical-sized loan.
So, are they worth it? And who is taking them? The i Paper takes a look.
How common are shorter loans?
The average mortgage term for a new buyer is 31 years, and loans of 20 years or less are very rare.
Some brokers say they are seeing slightly larger numbers take them on, but they still remain a minority product.
“We’re seeing a growing minority of borrowers deliberately choosing shorter mortgage terms, although it’s still nowhere near the norm,” says Stephen Perkins, managing director at Yellow Brick Mortgages.
“For many, it’s a psychological decision as much as a financial one. As retirement moves closer, the thought of still carrying mortgage debt becomes less appealing, so they’re prepared to pay more each month for the certainty of owning their home outright sooner,” he adds.
Samuel Mather-Holgate, managing director at Mather and Murray Financial, says some of those who take on the shorter products are influenced by the so-called Fire (Financial Independence, Retire Early) movement.
This is a personal finance phenomenon centered on extreme frugality, clearing debts and investing, to try and retire early.
“Some are chasing early financial freedom, often influenced by the internet ideal of clearing debt young and escaping the rat race. It is an appealing idea, but often unrealistic,” he adds.
I took out a 20-year mortgage at 25 – paying £200 extra per month
Craig Reid bought his one-bedroom house in Aberdeen around six years ago for £150,000 with a 10 per cent deposit.
Craig, 31, who works in the energy sector, opted for a 20-year term, around 11 years less than the average taken by first-time buyers.
Though the exact sum has varied depending on the rate, the mortgage has generally cost him around £200 more than if he’d taken a 30-year term.
But Craig says he has no regrets over the decision, as he’s now been able to pull equity to buy a buy-to-let, and says the prospect of having no mortgage by 45 is “psychologically very good to have”.
Craig Reid opted to take out a 20-year mortgage to avoid having more debt in later life“I’ve looked at the different arguments and I sat down with a mortgage advisor, but this seemed best to me,” he explained.
“If you accept the higher monthly price for what it is, you don’t notice it once it becomes the norm. If I had that extra £200 a month, would I use it well? Would I really invest it?”
Craig accepts that in Aberdeen, house prices are lower than some other areas of the UK and so following what he has done may be difficult for those living in more expensive cities. But he says for those who can afford to get a shorter mortgage “it’s a great thing to do”.
He add that it will give him multiple options later in his life.
“Paying down your mortgage over fewer years allows you to get better interest rates. It brings psychological benefits, whilst also building significant equity that can be used for buying your next home or future investments.”
What are the pros and cons?
In very simple terms, the longer the mortgage fix you take, the lower your payments will be.
But at the same time, the amount you pay overall will be far higher.
Homeowners are warned to pay off only as much as they can afford, including ensuring they will still be able to meet mortgage payments should other unexpected costs arise.
Dr Alla Koblyakova, an expert in mortgage finance at Nottingham Trent University, added: “Another advantage for short-term deals is that lenders may charge comparatively lower interest rates because of lower risks of borrowers experiencing shocks to their income and defaulting on payments.”
Paying your debt off quicker means you will access a lower loan-to-value (LTV) sooner, which means you are borrowing a smaller proportion of your home’s total value.
This generally gives you access to better interest rates.
As an example, with a 60 per cent LTV (meaning you have equity worth 40 per cent of your property value), you can get a rate of 4.24 per cent on a £250,000 mortgage.
At a 90 per cent LTV (equity worth 10 per cent), the best rate is 4.69 per cent.
Both rates are with Coventry Building Society, and on a 25-year term, the 4.24 per cent rate is around £60 a month cheaper than the 4.69 per cent deal.
The chart above highlights the difference in payments and total repaid on different mortgage terms.
The one below shows the different trajectories of debt repayments.
What are the other ways to cut your mortgage?
If you don’t think you can afford a shorter mortgage deal, there are other options to cut your costs.
The first is taking a longer-term deal and overpaying – usually pay a maximum of 10 per cent on it in an ad-hoc way. This allows you to clear your loan faster, but without the commitment to doing so.
“Some look for lenders allowing more than the standard 10 per cent annual overpayment, with the lender allowing as much as 30 per cent overpayment allowance on a fixed-rate deal,” says Nick Mendes, of John Charcol brokers.
Another option is initially opting for a longer term when you buy, but then reducing your term in the future.
“A small-term reduction at each remortgage is one of the main routes to shortening it over time,” adds Mendes.
Another, rarer option is something known as an offset mortgage.
This type of deal links your savings account to your mortgage. Instead of earning interest on your savings, the balance is subtracted from your total mortgage debt when calculating your monthly interest, meaning you only pay interest on the remaining difference.
“The savings also stay accessible rather than being tied up in an overpayment, which suits borrowers who want to cut interest without giving up the cash,” Mendes adds.
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