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Base Rate Cuts Will Slash Tracker Mortgages But Overpaying Would Be Wise In The Long Run

There are a great many homeowners who have tracker mortgages and therefore they will reap the benefits of the Bank of England interest rate movements. They will save hundreds of pounds per month when it takes effect in January, as their repayments shrink after yet another cut in the base rate by 1 per cent, to 2 per cent, following the 1.5 per cent drop in November and 0.5 per cent the month before that. However, they would be well advised to resist the temptation to spend the money they will be saving, but instead, continue with the payments that they were previously paying and overpay their loan each month.

As an example, last year, a two-year tracker mortgage, at 5.79 per cent, (0.04 per cent above base rate) with Abbey for 150,000 pounds would have been almost 950 pounds; when the cut rate comes in in early 2009 this will drop by over 300 pounds to 638 pounds. The figures then speak for themselves and if the overpayments are made this will make a massive difference to your mortgage over the loan period.

Basically, you will be able to substantially reduce what the biggest purchase of your life is costing you as you will be paying off far more of the capital value of your home, which reduces the outstanding capital and as a result the amount of interest will be instantly less. This will have a massive impact on your future mortgage also.

A homeowner with a 200,000 pound tracker mortgage now at 4 per cent, who paid an extra 50 pounds extra per month, would pay off the loan almost 2 years early and shave off a staggering 10,000 pounds from a 25 year mortgage, say mortgage broker Savills Private Finance.
Melanie Bien, the Director says, 'With the base rate slipping again, borrowers who are able to use the extra cash to plough straight back into their mortgage, and stick to it, will reap the benefits.'

The beauty of making over payments is that if your circumstances change and you find that you need the money you can revert back to your previous payment. Richard Morea of London and Country brokers, says, 'You've also the flexibility to conserve your cash. If the economic climate were to change again radically, you could easily swap back to paying the normal rate.'
The urge to spend this excess money will be over-powering for many, but, if the urge can be resisted it will be very wise to do so.

If you can comfortably afford to keep up the over-payments through the current economic downturn the rewards will be enormous further down the line if you need to re-mortgage. In such bleak financial times as the UK is seeing the falling base rate can be compared to a "golden handshake" for those lucky enough to have a tracker mortgage which is why it is so important that it is not squandered but is used to ease future financial burden.

Better rates in the future
Due to the credit crunch another benefit of overpayment has come to light. Lenders are wary, credit has dried up and there is extreme caution in the UK housing market.

Overpayment reduces LTV (loan to value) which is the ratio of mortgage debt against house market value this qualifies you lower rates when re-mortgaging. This will only affect those with a current tracker with a low 'margin'; margins have been increased for new borrowers. Nationwide offer a 2 year tracker at base rate plus 2.19 per cent if you have a LTV rate of 75 per cent.

When is it best to overpay?
Try to establish when your mortgage interest is worked out, if daily, as with many lenders, then your overpayment will have immediate affect on the calculation, but, if it annually, quarterly or monthly time your overpayment to be made when the calculation is made.

When interest is calculated on an annual basis pay overpayments into a high interest, easy access account and then transfer this payment into your mortgage just before the interest is calculated. Be careful however, to not pay any more than 10 per cent of overpayment in a calendar year as most lenders will make an early repayment charge which could be as much as 2 per cent of your loan.

Reduce or pay off debts
If anyone has expensive store card or credit card debts these should be paid off before much lower rate mortgages.

Frances Walker at Consumer Credit Counselling Service (CCCS) warns, 'If you've got plastic debts at 18 per cent, use the spare cash to get rid of these instead.
The same rule of priority applies if you're planning to use the extra cash to beef up your savings.

Invest in your savings
The same prioritisation should apply here. Michelle Slade at financial analyst Moneyfacts says, 'If you overpay on your mortgage, and then lose your job there's no way of getting that money back. Lenders won't take that [the months of overpayments] into account if you then struggle to pay your mortgage. A general rule is that if your mortgage rate is more than the savings rate after tax, then it's worth paying off your mortgage - and the reverse is true.'
Most penalty-free, highpaying accounts with instant access are all around 5 so people with trackers may think it would be more prudent to save especially if they may also want a mini-cash Isa with its tax-free status further boosting returns.

Top up your pension
If you put an extra 50-200 pounds a month into your pension you could boost it by tens of thousands of pounds during your working life according to Hargreaves Lansdown, independent financial advisors.
Paying an extra 100 pounds monthly, over 5 years into a work-defined or a personal pension would generate 6,982 pounds estimated on an annual growth rate of 6 per cent.

Head of pensions research at Hargreaves Lansdown, Tom McPhail says, 'It may be nerve-racking to buy in when the economy's on its knees, but if you wait for the green shoots of recovery you will miss out. Use regular payments, buy now and keep buying. In the long run you'll be glad you did.'

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