Repaying your Mortgage with your Redundancy
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This article first appeared on askaboutmoney.com
In normal market circumstances, banks take in deposits at one rate and lend it out at higher rates, so it makes no financial sense to have money on deposit at say 3% while paying 5% on your mortgage.
But these are strange times. Some people are paying their lender 2.5% on their tracker mortgages while their bank is paying them 5% or more on deposits!
Find the best variable deposit rate available...
on this thread. Say the best rate for up to €100,000 is around 5%. You will pay DIRT on this at 23%,
so the net rate to you after DIRT is around 4%.
Say the best rate over €100,000 is 4.5%,so the net rate after DIRT is around 3.5%.
It is important to stay flexible, so you want to find the best variable deposit rate which requires no notice or, at most, one month's notice. Circumstances may change - mortgage rates might rise and so you might want to pay off your mortgage. Don't lock it away for 12 months.
If your net mortgage rate is lower, then don't pay off the mortgage
If you have a tracker mortgage on which you are paying 2.5%, then it makes no sense to pay off your mortgage. Because of the tax relief on your mortgage interest, the net cost to you is even lower. Reducing your mortgage by €100,000 will save you €2,500 per year. But you will earn €4,000 on deposit, so you will be €1,500 richer at the end of the year.
If you have a Standard Variable Rate loan of 3.7%, it makes very little difference financially whether you put the money on deposit at 3.5% or pay off your mortgage at 3.7%.
If the Deposit rate is lower than the mortgage rate, then pay off your mortgage
It's usually a good idea to pay off your mortgage. But you might want to leave a small balance in case you need a mortgage in future. It's easier and cheaper to increase a mortgage than to get a fresh one.
If you make a capital repayment against a permanent tsb mortgage, you can take a payment holiday in the future if you need to.
If the net deposit rate and the net mortgage rate is around the same...
You might be better off putting the money on deposit for the time being. It's costing you very little and you retain access to the cash. If you pay off your mortgage, you might not be able to get it again.
If you are on a means-tested Social Welfare payment, you might consider paying off your mortgage.
This is a difficult one. If you have been unemployed for 9 months and apply for Jobseekers Allowance, they will means test you. If you have savings in excess of €20,000, your weekly payment will be reduced. So it makes sense to reduce your mortgage. Of course, if you are on Jobseekers Allowance you may well want the comfort of having some savings available.
Example of someone with €100,000 who is being means tested who does not pay off their mortgage
Interest received €4,000
Interest paid (3,700)
Reduction in Jobseekers Allowance: (2,800)
Annual cost of keeping money on deposit: €2,500
You should probably reduce your lump-sum to around €40,000
If you are more likely to spend money if it's available, then paying it off your mortgage is a good idea.
Some people find that money burns a hole in their pocket. If you are one of these, then you should pay off your mortgage rather than keep it on deposit. It is better to "lose" €1,000 a year, than squander the lot.
If you do pay a capital sum off your mortgage...
You will have a choice of keeping the monthly repayment at the same level and you will pay off your loan earlier. Alternatively, you can reduce your monthly repayment. There is no real advantage to either. It depends on your personal preference.
How safe is your deposit?
Deposits in banks in Ireland are very safe. But it is important to keep your money in a demand or no notice account, so that you can use it to repay your mortgage if things change.
If you have a fixed rate mortgage
You probably will pay a penalty for paying it off early. If you can get a fixed rate on deposit to match the term of the mortgage, then it is worth considering.
If you have a very old building society mortgage...
Interest on very old mortgages was sometimes calculated on the "annual rest" basis i.e. they calculated interest on 1 January each year based on the balance outstanding at the 31 December. If you have one of these loans, you must specify that it is a capital repayment to get the benefit of the interest saving.
This article applies to home loans only...
The principle is the same for residential investment property loans, but the tax relief on the interest paid would be higher which should result in a much lower net cost. So it is more likely that the owner of a residential investment property would be far better off putting the money on deposit.
