Liam Croke: Can your pension clear your mortgage?

Clearing off a mortgage early is probably up there at the very top of everyone’s financial wish list – but hoping it happens and making it happen are two very different things.

Clearing off a mortgage early is probably up there at the very top of everyone’s financial wish list – but hoping it happens and making it happen are two very different things.

I am always asked by people how it can be done but there is no secret to repaying a mortgage early, and people typically know what needs to be done – you can either make lump sum repayments against it, you can regularly overpay each month and if you really want to pay it back as fast as you can it is a combination of both of these methods.

But there is another way that can be used in its own right – one that I’m going to outline shortly.

But before I do, I want to tell you about a client of mine who – like everyone else – wants to be mortgage-free as fast as he can. Using his real-life example is a more effective way of me showing you the impact of what needs to be done.

So, let me give you a bit of background on him. He lives in Dublin and has a mortgage with BOI. He owes €320,000 and the term remaining is 24 years. He is 41 and his goal is to have it repaid when he is 60, not when he turns 65 – and his question to me was how can this be done without it having a major impact on his current standard of living.

Of course he doesn’t have to keep the mortgage for the time period that was initially on their letter of offer, although BOI in his case would like it if he did because he will pay them back c. €178,300 in interest payments over that amount of time.

The first method of accelerating the repayment of any mortgage is by making a partial redemption against it by way of a lump sum lodgement. When you do this you basically have two options; you can either (a) reduce your term or (b) reduce your monthly repayment – so in my client’s instance if he was to take, for example, the sum €20,000 off his mortgage, it would have the effect of either:

n Reducing his monthly repayment by around €108.

n Reducing his term by around two years

So, a lump sum of €20,000 against his mortgage would reduce the term by two years – he now needs to reduce the term by another three years if he wanted to reach his goal of becoming mortgage-free at 60. This will be achieved by making an overpayment each month.

Overpaying each month is something that I always recommend to people if they have a mortgage, particularly a non-tracker mortgage, because the impact it can have is fantastic. Overpaying your mortgage gives you an immediate return of whatever interest you pay on the balance outstanding.

Let’s say the rate is 3.95%: in order to get the equivalent rate in a regular savings plan, you would need to be earning circa 6.69% which is not on offer from any bank.

The monthly overpay-ment amount my client needed to make, to reduce his mortgage by three years was €140 and if he did this along with paying one lump sum of €20,000 he would achieve his goal of becoming mortgage-free at 60.

But there is one other way that you can repay your mortgage in full and it is an area that not many people consider and it is using their pension fund. From the age of 50 onwards, if you were a member of an occupational pension scheme, the scheme rules may allow you to take your benefits from that age, which means you could get access to around 25% of the value of your fund tax free. If you have a personal pension or a PRSA, the earliest age you can take benefits from your pension fund is 60 – and the only way you can get access to them earlier is through ill health.

When I was working out those figures for my client, I noticed that if he made that lump sum lodgement and monthly overpayments, in year 2031 – when he is 55 – the amount outstanding on his mortgage would be approximately €114,000.

He had a pension and if he continued making contributions to his pension along with his employers’ contributions, the amount he would accumulate along with what he had built up already would, at age 55, amount to around €393,000 assuming annual growth rates of 5%.

If he was to take 25% of this amount it would equate to €98,155 – and if he used this amount towards repaying his mortgage the balance outstanding then would only be €15,844 – which of course you might hope he would be in a position to repay in full.

So, rather than having his mortgage cleared at age 60, he could in fact have it cleared when he is 55, a full 10 years earlier than planned if he was to follow this strategy by using his pension fund.

The amount he is contributing to his pension fund each year is €5,489 but this is only costing him €3,293 after tax relief and he is also effectively getting free money from his employer when they put matching money into his pension fund. But the major advantage is that he is then using it to repay a personal debt.

The big advantages, and I believe there are three, to clearing your mortgage off earlier are the amount of interest you would end up not paying your lender (better in your account than theirs), the mortgage repayment you no longer have to pay which can be applied to other areas of your finances and finally the amount you would have been paying on a mortgage reduces the amount you would need to earn each year. It is worth exploring further, because some strategies achieve the same outcomes. But this is one possibility that just might cost you much less than the others.