Tumbling mortgage rates means more money in the pocket of homeowners. Rather than spending it on a new plasma TV, you're much better off paying off your debts, including your house.
This whole recession has one silver lining - sharply lower interest rates, benefiting thousands of home-owners on tracker mortgages and variable mortgages.
I recently wrote about how one person on our popular discussion boards had given himself the mother of all pay rises. To quickly recap, `bingcrosby' found his lender's Standard Variable Rate is just 3.49%, meaning that when his current fixed-rate deal runs out, he will effectively double his disposable income.
The Bank of England is slashing interest rates because we are in recession. Lower interest rates encourage consumers to spend more.
It also encourages businesses to borrow money so they can grow their businesses, presuming of course they can find a bank willing to lend to them, and they have more customers willing and able to buy their goods and services. Right now, that's a big ask, but that's a story for another day.
The $64,000 question for `bingcrosby' - and the thousands of others who have suddenly found themselves with a lot more disposable income - is: what should we do with it?
We're Sorry Mr Brown
The government would be keen for us to spend some of it rather than save it, giving the economy a timely boost. They would rather businesses grow rather than contract, reducing unemployment and the threat of deflation.
But the unfortunate reality of this recession is that it's every man, woman and child for themselves. We're sorry Mr Brown, but our first priority is to keep our job. Our second priority is to reduce and pay off our debts. Our third priority is to make sure if the worst does happen, and we do lose our jobs, we have a savings buffer so we can maintain our mortgage repayments and feed and clothe ourselves.
It all means we cut back on our discretionary spending. It also means the recession lasting longer. It's the classic Catch-22 situation.
Pay Off Your Mortgage 9 Years Early
It seems HSBC (LSE: HSBA) is on the same wavelength. The bank recently wrote to 30,000 of its tracker and variable rate mortgage customers to explain the benefit of overpaying on their loans.
They said a typical UK borrower who took out a new tracker mortgage in October 2008 for £112,756 over 25 years, is now saving £218.08 per month compared to their initial payment. Adding this sum to mortgage payments for the rest of the term would reduce interest costs by £13,817 and pay off the mortgage 9 years and 3 months early.
HSBC have produced this table showing how much customers can save by overpaying their mortgage. It is based on a tracker mortgage rate of 3% and a customer borrowing £150,000 over 25 years.
| Monthly Overpayment | Reduced term by | Saved interest costs |
|---|---|---|
| 100 | 4 years 3 months | £11,842 |
| 200 | 7 years 3 months | £19,894 |
| 300 | 9 years 6 months | £25,738 |
| 400 | 11 years 3 months | £30,181 |
You can do the math yourself using our overpayment calculator.
Beware, Interest Rates Can Go Up As Well As Down
At the same time, they do caution that interest rates will increase at some point and it will feel painful for those borrowers who have soaked up the benefit of lower mortgage payments by extending their spending habits rather than making additional mortgage payments.
You have to admire HSBC's sensible advice. In days gone by, they'd have probably been sending out letters to their mortgage customers urging them to take out a credit card or even consider increasing their mortgage so they could do some home renovations. You need somewhere to put that new 42" plasma TV, bought on your new credit card, don't you?
How things have changed.
In these tough economic times, it makes absolute sense to overpay your mortgage. It makes even more sense to pay off any other debts first, because they will likely be being charged at higher rates of interest. For example, whilst mortgage interest rates might be 3.5%, credit card interest rates are likely to be more like 15.9%, 19.9% or even higher.
3 Simple Words Of Advice
My advice would is simple, and is the same advice in recession as it is in boom times.
1) Use any additional disposable income, for example, because your mortgage repayments have fallen, to firstly pay off your most expensive debts, likely your credit card or an unsecured loan. Take out a 0% balance transfer card to get rid of this debt more quickly.
2) Once you have all your high interest debts paid off, overpay your mortgage. As the helpful folks at HSBC have highlighted, you can knock years off the term of your mortgage.
3) Stay healthy and enjoy life.
If you want to see just how low you can get your mortgage rate, use our no-fee mortgage service a try for starters. It's an absolutely free service. All you've got to lose is your existing high mortgage rate.
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