When I am sitting down with parents to carry out their special needs trust plan. One of the areas I discuss with parents is the family home.
My initial questions are always on how much they owe on their mortgage and how much per month do they pay. The reason I am so interested in this is that I am always trying to figure out, what assets parents have and what can be potentially passed on to their child through the trust.
As parents are about to answer this I always take a deep breath because I know from experience that this one area has huge knock-on consequences to all other financial areas.
For instance, if parents have a large mortgage then their salary is minimised as take home pay after paying taxes & their mortgage might be no different to a family with a very small mortgage and an average job. Sometimes families with a small mortgage are often in a better place to fund their child’s trust.
I am always encouraging parents to clear their mortgage early. Parents are unaware that if you keep your mortgage for the full term then they should expect to pay the bank back thousands more than they original borrowed. To put this in perspective, if you borrow €250,000, on average with a standard variable rate over 30-years expect to pay the bank back around €150,000 extra over the lifetime of the mortgage. Can you now guess why banks are always telling parents not to clear their mortgage early?
Some parents had the foresight or luck to have a tracker mortgage. What this means is that the interest they pay back to the bank is controlled by the European Central Bank rate, not the banks. Banks control the fixed and variable rate mortgages and generally, this will be 4-6 time more expensive than a tracker mortgage.
Crystal Ball Moment
Be prepared, interest rates are at an all-time low at the moment. Anytime I talk to my dad on this topic he keeps telling me about interest rates being 16% when he was my age. I think what he is saying which I agree with him on is that all interest rates, including tracker mortgages are going to increase and everyone should be prepared to pay more each month over the next few years.
When should you pay off your mortgage?
It doesn’t make sense to chip away at your mortgage if you have other borrowing such as credit cards, credit union loans, personal loans or car loans as the interest on these products is much higher.
If you are financial advanced enough that you don’t have any personal loans and you have a little nest egg together for the rainy day, this is the time to look at reducing your mortgage debt.
The first option is to increase your monthly payments or pay the bank a lump sum and this will then reduce your term. For instance, your mortgage may be finishing in 2030 but because of your increase payments, it will now finish in 2025. This could save you tens of thousands of euros.
My preferred option is to pay a lump sum off the capital of the mortgage each year. This means that the balance of the mortgage reduces but the term stays the same. Why I really like this option is that it reduces your monthly mortgage repayments, easing the pressure of paying your mortgage and still saves you thousands when you pay off your mortgage early.
Either way, you are not going to go wrong but I think that most important thing is to get into the mind-set and habit of finishing your mortgage early. This then puts you in a very strong financial position so you can be in a better position to fund your child’s trust.
Here is a link to a mortgage calculator that you can mess around with to see how much you could potentially save by paying your mortgage off a little bit earlier.