Lizzi Seear is one of the growing legion of home-owners who has opted to
reduce her monthly mortgage outgoings by repaying interest only.
Instead of making capital repayments costing £859 a month, she is paying only
£550 — the interest on her £158,000 two-year fixed-rate loan with Halifax at
4.29 per cent.
Lizzi, a 35-year-old free-lance market research consultant from Middlesex, is
growing anxious that she does not have a plan in place to pay off the
capital at the end of the term in 20 years. She says: “I am worried because
I am not being consistent, but I have no idea what the best option is.
Should I switch to capital repayments, pay off chunks when I can, invest in
Isas or offset the loan?”
Over the course of last year Lizzi overpaid by 10 per cent — the maximum
allowed on her mortgage — to reduce her balance by £3,000. However, she is
nervous about switching to full capital repayments because her income is
erratic, so there is a greater risk that she would not be able to meet her
monthly bills in some months.
At the moment, she is earning £350 a day on a project in London, but it can be
lower on other projects, at about £200 a day. Sometimes invoices are paid
immediately, but often they take months to be paid. “I can be waiting for up
to three months for cheques,” she says, “so I can never depend on one
payment.”
Lizzi estimates that her current earnings amount to about £80,000 a year but
says that the annual average is probably £55,000. She says: “It seems to
make more sense having an interest-only mortgage because of the flexibility
— sometimes I can afford to make capital repayments, other times I cannot.”
The value of her three-bedroom terraced house in Staines has already risen by
£50,000 in the two-and-a-half years since she bought it, from £170,000 to
£220,000.
But Lizzi knows that she cannot rely on house-price growth alone to pay off
the capital and has already put aside some savings. She has savings and
investments worth a total of £22,500. About £6,000 of this is Lizzi’s
emergency fund, half is kept in a National Savings & Investments cash
mini-Isa and the other half in a Royal Bank of Scotland cash mini-Isa. There
is another £4,000 in an Alliance & Leicester Plus Saver account,
linked to her current account, which Elizabeth dips into for holidays.
A further £12,500 is invested in a stocks and shares Isa with Hargreaves
Lansdown, spread between a mix of funds in several sectors, including UK
all-companies, Europe, UK equity income, UK smaller companies, North America
and Asia Pacific. It has performed well, rising from £9,000 four years ago
to a value of £12,500 now.
Although Lizzi is happy with the way her investments have performed, she
remains cautious. “The stock market could plummet in a year,” she says,
“then what would I have?”
She is now wondering whether to use the cash to pay off her mortgage capital.
But the problem with doing this is that she may sacrifice some of her
pension pot.
Lizzi has little pension provision. She contracted out of the second state
pension two years ago and has three small pensions from former employers.
One will provide her with a tax-free lump sum of £1,193 and an annual income
of £697 in retirement. The other two are worth £7,241 and £218. She says:
“Because I have moved between employers frequently and my income has always
varied, it has been difficult to save for a pension. For some reason I am
not too worried, although I suspect that the advisers will tell me I should
be.”
Lizzi wants to get her priorities in order. Should she be paying off her
mortgage, investing in the stock market or saving in a pension?
Lizzi Seear: What the experts say
MORTGAGES 1
Jonathan Burridge, adviser, Quantum Mortgages
“Lizzi now needs more flexibility than her Halifax deal offers. When she comes
to the end of her current deal in August, she will probably face a big rise
in repayments even if she takes out another fix. I would recommend that she
stays with fixed rates and fixes for as long as possible to give her
certainty. At the moment, there are low five-year fixes at about 5.5 per
cent.
“The lowest fixed rate over five years is Woolwich’s 5.49 per cent deal until
April 2012. This would cost Lizzi an extra £140 a month. The downside is
that she would again be restricted to a 10 per cent annual cap on
overpayments.
“To obtain more flexibility, Lizzi will have to pay a higher interest rate.
Northern Rock offers a good range of flexible fixed rates, but to enjoy the
flexibility to overpay in feast or underpay during famine she would be
charged 5.69 per cent for five years. At this premium, Lizzi would have to
be absolutely certain that she would use her savings to pay off big chunks.”
MORTGAGES 2
Andrew Montlake, head of mortgages, Cobalt Capital
“Lizzi should stick with Halifax until the end of the term in August because
this is an excellent fixed rate. But she needs to brace herself for a rise
in outgoings when she remortgages.
“It is a good idea to look at a more flexible deal that will allow her to pay
off more than 10 per cent a year. Northern Rock has a number of flexible
fixes that allow you to pay down the loan to £1 without penalties.
“When times are good, Lizzi can pay off as much as she can afford, which could
be more than she would pay otherwise. The advantage is that she can also
borrow back the overpayments at the same rate.
“Bank of Scotland has a similar variable-rate tracker loan, which allows the
borrower to pay in and withdraw funds as and when required via a chequebook
facility. However, this approach will work only if Lizzi is strict with
herself.
“If she feels that she cannot afford a pure repayment loan, Lizzi could switch
to a mortgage that is partly a repayment loan and partly an interest-only
loan, giving her the best of both worlds. This can be done at any time,
although Halifax charges a small fee.
“Lizzi would probably be better off taking a lower rate with flexible
repayments than taking out an offset deal because offsets tend to have
higher rates.”
SAVINGS & INVESTMENT
Anna Bowes, adviser, AWD Chase de Vere
“Lizzi should view her investments as a way to pay off the mortgage in the
future and continue to add to them in the meantime. She may wind up with
more savings than she needs, which can then be used for other expenses or
put towards retirement.
“Her investment spread appears to be well balanced. Investing in the stock
market should be a long-term strategy — encashing the lot and paying off her
mortgage is a bit drastic. It is better to have a balance, paying off some
of the mortgage but maintaining savings as well. She could squeeze more
interest from her Isas by transferring them to Kent Reliance Building
Society for a more competitive 5.46 per cent.
“As a higher-rate taxpayer, £4,000 is rather a lot to be holding in a nonIsa
account. If Lizzi doesn’t need this much and still has some Isa allowance
available this year, she could transfer some of it before April.”
PENSIONS
Tom McPhail, head of pensions, Hargreaves Lansdown
“Lizzi should contact the Department for Work and Pensions on 0845 3000168 to
obtain a forecast of her state pension entitlement. She can then use an
online pension calculator, such as the Financial Services Authority
calculator at www.moneymadeclear.fsa. gov.uk, to plan how much she should be
saving. This is particularly important because of Lizzi’s fluctuating
earnings.
“If Lizzi saves 10 per cent of her income every year until she retires, this
will produce annual pension income of about £13,500. If she delays for five
years, the projected income drops to about £9,500.
“Higher-rate tax relief on pensions is too good to give up. I suggest that
Lizzi continues making periodic payments to reduce her mortgage debt, but
she should adopt the same approach with her pension. By using a flexible
self-invested personal pension (Sipp), she could make periodic lump-sum
investments and could invest in actively managed funds.
“She would keep the flexibility of being able to vary her contributions
and would be able to transfer her other pension pots into the Sipp, but she
must not delay.”
Lizzi's response
“I am definitely going to start a pension. Not taking advantage of 40 per cent
tax relief is stupid, and I like the sound of a self-invested personal
pension.
“I will also be moving my two cash Isas to accounts with better rates. I am
obviously not making quite enough of these.
“When my mortgage deal comes to an end in August, I will switch from an
interest-only arrangement to capital repayments. To be honest, I’m not sure
whether I will keep overpaying because any money I use to overpay is money
that I am not putting into my pension, which I think should be my priority.
“From now on, therefore, I aim to have a fixed amount going into mortgage
repayments and a fixed amount into a pension fund. This will help to give me
the long-term security I need.”
Would you like a financial makeover? Write to Money, The Times,
Times House, 1 Pennington Street, London E98 1TB, marking your envelope
Money MoT, or e-mail moneymot@thetimes.co.uk. Please include current
finances, your short and long-term goals and a daytime telephone number. You
must be prepared to disclose your income and be willing to be photographed.
