Paying Off Your Mortgage Could Give You A Financial Heart Attack

This is how you could, with all the best intentions in the world, walk yourself into having a financial heart attack when paying off your mortgage.

Your outstanding mortgage

Let’s say you:

• owe £120,000 on your home mortgage.
• have equity of £180,000 in the property, i.e., the property is valued at £300,000.
• have 10 years left on your mortgage. 
• are on a variable rate of 4%
• are on a repayment mortgage.
• Terms and conditions of your mortgage allow you to repay as much as you want each month without penalty.

Your available cash

You’ve just moved jobs and got a pay rise. After calculating income and expenses you realise you are in a very fortunate position to have an extra £700/month available to invest, save or pay down the mortgage.

Decision to pay off your mortgage

However, this mortgage is really bothering you and you just want it gone.  After all, you’re in a secure pensionable position. What could go wrong?

Your cash and investments

You check your:

• ISA and see that your investments, which you have been slowly building up over the past few years, have a value of £16,000. 
• savings account, which is where you have your emergency fund, and see that it has a value of £5,000.

You use a mortgage overpayment calculator which shows that a £21,000 lump sum overpayment will:

• save you £8,980 in interest over the lifetime of the mortgage.
• help you clear the mortgage debt 2 years early.

Paying off your mortgage

Without a second thought you cash out the full value of your ISA, which is £16k. You take the £16k cash from the ISA and £5k emergency fund and use it to pay down your mortgage.  

The mortgage debt has now dropped to £99k and you only have 8 years left on the mortgage. You feel great. You are now much closer to being mortgage free.

Enthusiastically, you use the £700 extra amount from your salary each month to pay down the mortgage.

Assuming the mortgage rate stays at 4% for the following year, you have £79,730 left to pay on the mortgage.  In less than 4 years you will be clear of it. You can’t wait.

Murphy’s Law – what can go wrong will go wrong

However, you go into work and hear rumours of redundancies. You’re not worried. Afterall, it’s a secure pensionable position, right?

Wrong. It seems your managers have other ideas.

The Human Resources Manager calls you into her office and says ‘Sorry, the company has decided to make you redundant. As you have been with the company less than 18 months, you are not eligible for statutory redundancy pay’.

You leave the office shell shocked. You thought you were safe. 

How paying off your mortgage will give you a financial heart attack

You work out your one month’s notice and get your final paycheck the next month and pay your mortgage and expenses. You have no money left. 

Immediately, you think about all the overpayments you made which are now locked in the house. Remortgaging is now not an option as you have no job.

You have no savings at all as you put everything into paying down the house.

You have no other assets to sell.

Relatives are not able to loan you any money.

The one credit card you have is maxed out. 

Soon, utility bills, your mortgage and credit card payment are due. They all bounce as you have zero money. Before you know it, the utility companies are on your back looking for payment, the mortgage company keeps sending you letters looking for payment and warning you about repossession and the credit card company is screaming for payment. 

Bills are due but you have no available cash.

Congratulations, you have given yourself a financial heart attack!

You can see from the example above that putting every penny you have into your home could leave you dangerously exposed. In a worst-case scenario:

• the bank would repossess your house.
• the credit card company and utility companies may take you to court
• your credit score will tank. 

Lessons learned when paying off your mortgage

The lesson is that if you wish to pay off your home, you can do so.  However, you must have enough liquidity to cover at least 6 months of expenses in the event of you, for example, losing your job or some other major adverse life event happening. 

What is liquidity?

Liquidity describes how easily you can convert an asset into cash without losing its value. An asset is something that you own or have a right to, that has monetary value.  Examples include money, property, stocks, bonds, vehicles, jewellery etc.

Cash is the most liquid asset, because you can use it to buy/pay for anything at any time. However, other assets may have different levels of liquidity, depending on how quickly and easily you can sell them for cash.

What you can do

In the example above, you had £700/month available cash. If you really want to pay the mortgage down, you could perhaps take 50% of this to pay off the mortgage and save or invest the remaining 50% to ensure you continuously have liquidity whilst paying down mortgage debt. 

Advantages to paying off your mortgage

Many people say that paying off their house is the best thing they have ever done. They have zero regrets about doing so.

• The ground feels steady. You own your home outright. This gives security to you and your family. 
• You can sleep better at night.
• Moreover, you save thousands on interest payments, especially in the current environment where interest rates are high.
• Not having a mortgage payment frees up cash that you can put into investments that compound over time increasing your wealth.

Disadvantages to paying off your mortgage

However, there are some disadvantages to this.

• You lose liquidity. Paying off your mortgage means that your money is tied up in the bricks and mortar that is your home.  It may be impossible or very expensive for you to remortgage and pull that money back out in the event of an emergency or perhaps a great business opportunity.
• You may miss out on greater investment returns. In times of low interest rates, perhaps investing in other assets like stocks or real estate may have given greater returns. However now with high interest rates this may be less so.

In Summary

Paying off your mortgage gives you peace of mind and security. However, the way you pay off your mortgage is important.

Always ensure you have sufficient liquidity, alongside paying off your mortgage, to give you a financial cushion that will protect you from any of life’s adverse events. Such a cash cushion will help prevent you from giving yourself a financial heart attack!

DISCLAIMER: Inquisitive Finance operates on principles of exchange of knowledge, ideas and opinions and learning in the community. Your decisions are entirely your own responsibility, and I am in no way responsible for your actions. I am not a financial advisor. Whilst I strive to provide accurate and up to date information, I make no warranties or representations as to the accuracy or completeness of this information. Use common sense, do due diligence and where necessary, use the services of a licensed financial advisor, before making any financial decision and/or transaction.