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What to do with your mortgage rate reduction bonus?

Irish News of the World

Sunday March 22nd, 2009

Diarmuid MacShane

What to do with your mortgage rate reduction bonus?

One of the better financial news stories over the past few months has been the massive drop in interest rates. The fall in the ECB interest rates has meant that a lot of us have a lot more money in our pockets recently.

Since October 2008, because of the global financial difficulaties, the European Central Bank has slashed interest rates by 2.75% – the last 0.5% drop was in March of this year.

For those with variable or tracker rate mortgages that’s a drop of 60% in the cost of our mortgage repayments – you won’t see too many discounts like that anywhere else.

If you’re on an average size mortgage, all these drops mean that you’ve got over €500 extra each month. That’s a sizeable €6000 per year. And it’s not expected to be the end of it either – it’s thought that there will be another rate cut in May if things don’t get much better before then.

But what are you doing with all that extra cash? I hope you’re not just letting it sit in your bank account where it’s getting slowly spent each month, or even just earning 0.1% interest like most current accounts pay out?

With these tough times upon us at the moment, now is the time to make the best use of that extra cash so that things will be a little easier between now and when things pick up again.

So what should you be doing? In the following order, here are a few things to think about.

Pay off expensive debt first.

While you might think that you could start paying off your mortgage first, remember that it’s only costing you between 3 and 5 or 6%. If you have outstanding balances on your credit card it could be costing you anything up to 24% interest.

Use your extra mortgage money every month to start paying off your credit card bill. By cutting this expensive debt, you’re getting the double benefit of reducing that debt, but also potentially freeing up even more cash every month for yourself.

If you’ve borrowed from a money lender, then this is a debt that you should definitely pay off completely with your extra cash as soon as you can. Interest rates from money lenders, even legitimate ones, will normally be up to 23% and sometimes more. Save yourself the future hassle and clear down this debt.

Pay off personal loans

Next on your hit list should be to pay off any personal loans that you may have. These bank loans are likely to be the next most expensive borrowings that you have – anything up to 14% at the moment. Your overdraft would fit into this same bracket as well – overdrafts can cost anywhere from 9-15%.

Remember though – check the terms of your loans to see if there are any penalties for paying them off early – this is most likely on fixed interest loans. If the charge isn’t too much and you think it’s worth while, clear down these personal loans as early as you can also.

Any more debts?

Do you owe anyone else any more? The credit union? Subs from work? Or do you owe your family or friends any money? See about using your extra cash to clear these debts as well. No one likes having debts hanging over you when it comes to family and friends, so it’ll be in everyones interest to pay these off too.

What comes next?

If you’re now in the happy situation where your higher cost debts are gone, or mostly under control, what happens now?

Well, first of all you should review if, or how, you’re going to borrow in the future. It’s always said that the easiest way to get money from a bank is to prove that you don’t actually need it in the first place.

With your debts under control, maybe now you could apply for a lower rate credit card, or a lower rate overdraft? AIB and Bank Of Ireland now offer credit card rates of 8.5% and 9.5% for qualifying customers – much less than the standard market rate. And National Irish Bank offer some customers an overdraft rate of less than 9%.

Now pay off the mortgage?

I would suggest one final thing to examine before starting to pay off your mortgage. Check out what your upcoming expenses for the rest of the year will be?

What will you spend your money on that you would normally be borrowing for? This could be a holiday in the summer, a car service and NCT, some DIY and garden expenses in the summer, or even back to school expenses for the kids in September – even Christmas.

If you still have a little cash left over – from your mortgage bonus, and reduced repayments on your other loans – maybe you could start to save a little so that you don’t end up going back into debt?

The range of regular savings accounts is still pretty good at the moment, though the falling interest rates mean that some aren’t as attractive as they used to be. Anglo Irish Bank has an account paying 7.3%, and Bank of Ireland has one paying 7%. Some regular savings accounts have minimum monthly amounts ranging from €1 to €100 depending on the institution.

Finally, pay down your mortgage early

Once you’ve the rest of your debt covered, you can now look to overpaying your mortgage repayments. If you chose this option, make sure you clarify (in writing if possible) with your bank that any overpayments are to be knocked of your principle loan amount. There have been cases where disagreements have arisen over this, and the customer can lose out if they’re not clear on their requirements.

There is a huge attraction to paying off your mortgage early. Say you have €200,000 mortgage for 20 years at 4.5%. If you overpay by about €100 each month, you could save yourself up to €15,000 in interest payments and cut your mortgage by nearly 2 ½ years.

But this is really only best done once you’ve addressed your other higher costing debt first!

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