The National newspaper recently featured a reader’s personal finance problem and requested expert mortgage advice. Our Managing Director, Jean-Luc Desbois was asked to provide the reader with advice on whether to overpay their mortgage or not. Read on for his advice;
Question: My mortgage allows overpayment of 25 per cent of the remaining balance without penalty. It also allows reducing the loan period without penalty. I have a variable-rate product linked to Eibor currently costing me about 4 per cent. With the Fed funds rate likely to tick up this year should I overpay or reduce the loan period? And should the likely trajectory of interest rates influence that decision? MM, Dubai
Answer: If you have no planned short- or long-term cash requirements for the surplus funds, you may want to pay down the loan, as you are unlikely to receive 4 per cent on your deposits any time soon. However, if you are likely to have capital requirements in the future for school or university fees, travel, relocation, automobiles or renovation, sit tight.
It is important to maintain an adequate cash reserve or rainy day fund, particularly if there is any possibility of changes in circumstances.
Although interest rates have gone up and are likely to increase later this year, we do not anticipate them rising to significant levels in the short term. As the saying goes, “cash is king”, so ensure you have adequate liquidity which in turn provides flexibility and options. The lessons of the past 10 years are not to over-commit or be too heavily invested in one asset or asset class. Remember, 4 per cent is still a good rate. If and when rates increase, start phasing the extra payments in to keep the monthly repayments at manageable levels.
Finally, I recommend maintaining mortgages over the maximum term available for most borrowers. If you have to leave the property or country, the mortgage repayments should be covered by any rental income. You can always reduce the outstanding amount with top-up payments. This provides you with low monthly fixed commitments with greater flexibility and control.
Originally published in: http://www.thenational.ae/business/personal-finance/money-clinic-when-does-it-make-sense-to-overpay-on-a-mortgage