Regular spending

Starting with the biggest first, let’s cover some high-impact areas of core spending. To reiterate, I’m not going to tell you what’s the cheapest or best deal; I want to help you understand how finance works in each category so that you’re better informed and can make the right decision for you. There are many comparison sites out there but fundamentally they all focus on the cheapest deal and while I’m not saying cheap isn’t good, I don’t believe they help you understand what you’re actually paying for.

Mortgages

Banks will lend you money but never forget that they want to make money out of you and are good at hiding how they do this. Interest rates are a key element of mortgages and we’re coming out of a long period of historically low rates, so it was always going to be painful when they went up from such a low base. At the time of writing, the Bank of England base rate is 5%, which I consider low against the 8% we were paying when we had our largest mortgage balance and very low against my parents’ mortgage rate of 15%, which I recall from my childhood.

Property has historically proved to be a good investment over the long term and, despite the scary rates, I still took my dad’s advice and got onto the property ladder as soon as I was able to while in my first job. Over the past 15 years, average house prices have risen from around £155,000 in 2008 to £290,000 in 2023. For most people, it’s going to be a struggle to get on the first rung of the ladder, let alone keeping up with changing payments, but you need to build affordability into your plan and approach mortgage payments as a priority. I couldn’t get a mortgage when I was looking to buy my first house, as no one would lend against my combination of salary, deposit and the cost of the house. I was a little cheeky in that I asked to see the company’s finance director, explained my position, stated that I liked working there and wanted to stay, and was there any chance of a small pay rise to allow me to get the mortgage? I remember him saying that no one had ever asked him that before but I must have made a good impression because he agreed!

One of the single most important decisions we made, which has given us our financial freedom, was to focus on paying off our mortgage. The interest you pay to the bank is huge and the sooner you can reduce it, the better. So it’s time for some maths to show you what you’re really paying for and why it should be your number one target.

Consider a house worth £250,000. You have a £25,000 (10%) deposit and a repayment mortgage over 25 years at 6%. A quick online calculator gives us a figure of £1,449.68 per month. This is where most people stop. But think about the numbers: 25 years, 12 months per year at £1,449.68 a month – that’s £434,904 in total. You borrowed £225,000 (house value less the deposit) and you’re paying the bank £209,904 in interest. Yes, they’re lending you a large sum of money (and not without risk) but do you realise what you’re really paying in total? It’s nearly the same as the value of the house! If you managed to squeeze another £5,000 onto the deposit, you’d save £9,666 in interest payments. The effect of overpaying can’t be underestimated either. In the example above, overpaying an additional £200 a month would allow you to pay off your mortgage nearly six years earlier, saving £56,000 in interest payments.

There’s another hidden cost of the repayment mortgage, especially if you think you’re saving money by remortgaging frequently. You’re probably not. The average person in the street might reasonably assume that their mortgage balance would be reduced equally each year; in other words, they will have paid back 1/25th of the mortgage every year, or £9,000 a year in our example. I’m sorry to say they’re wrong. Thanks to the cunning way that financial institutions construct their mortgages, they decide to split it differently through the term of the mortgage, with a heavy bias towards interest in the early years. Using the same example above, in the first year, you’ll have paid £17,396 to the bank and whereas you might have thought (hoped) that £9,000 was going towards reducing what you owed on the house, the bank only paid £4,005 against the house and took the remaining £13,391 as interest. And it continues like this on a sliding scale towards the end of the mortgage. In fact, it’s not until year 15 that you actually breach the £9,000 payment against the property. But who keeps the same mortgage for 15 years? Unless you’re locked in for five or 10 years, many people remortgage every three or four years, often with a hefty admin fee and the lure of the interest rate they’re paying. What they’re missing is that they’re effectively extending the life of their mortgage (and increasing the total interest paid) without realising it. Figure 4 demonstrates a typical repayment schedule, clearly showing that in the early years you’re paying much more interest than reducing your loan size.

So I’m in favour of overpaying your mortgage as much as you can (although most banks don’t like this because it dents their profits, so they limit you to a maximum of 10% a year in overpayments) and not remortgaging too often. One critical point to note (and to avoid a sneaky banker ‘trick’) is to check with your mortgage company that any overpayments will be deducted from the amount owed and the interest element reduced accordingly. Some have been known to recalculate the mortgage balance annually and to hold the overpayments as prepayments against interest, generously allowing you a payment holiday in the future – in other words, they’re taking your money without any benefit to you.

I prefer interest-only mortgages, with the caveat that you must have the discipline to make overpayments against the capital amount. With the same mortgage, it would cost you £1,125 in interest payments in month one but as soon as you make an overpayment, it comes off the amount owed and the interest payable reduces. An interest-only mortgage is even better if you can tie it to a bank account, where it becomes an offset mortgage. Here your current account balance offsets the mortgage balance (effectively reducing it), which maximises the effect of reducing your mortgage balance. If you have any, you can even use it to spice up your savings; rather than having savings earning 3% interest, why not hold that balance in your offset account and effectively earn 6%? The benefit is paying off your mortgage earlier and significantly reducing the amount of interest you pay. It also could save you some tax as you won’t be getting ‘paid’ any interest on your savings, rather you pay less interest on your mortgage.

In summary, I can’t pay your mortgage for you but I can open your eyes to the value of prioritising paying it off early. However, not everyone agrees with this approach. A quick internet search of financial strategies will corroborate this, but I’m in the camp of ‘pay off your biggest debts as soon as possible’ and I can guarantee you that paying off your mortgage is the biggest stress relief there is.

Car finance

Whether you’re a petrolhead or view your car as purely a means to travel from A to B, UK consumers appear to have drifted into accepting car finance as a default option and changing vehicles more frequently. Data published in 2023 by the Finance and Leasing Association shows that, despite a falling number of deals, the total new business for car finance in 2022 ballooned to more than £40 billion. What’s more worrying is that, unlike with mortgages, there doesn’t appear to be the same level of due diligence and affordability checking to prevent people from sleepwalking into an expensive way of buying a car. Some might argue that it’s a cheap way into car ownership, but in reality a lot of car finance isn’t ownership, it’s leasing (renting) and ties you into forever paying ‘rent’ for your car. Putting some statistics around this, new car drivers financed on average £25,325 in 2022, with more than 2.2 million drivers entering car finance agreements, up 3% on 2021. This happened while we were in the middle of a cost of living crisis. And what does everyone know about buying a brand new car? Yes, it loses a massive chunk of value and depreciates the moment you drive off the forecourt. Data changes quickly but an internet search shows some interesting trends: of the top ten slowest depreciating cars, all cost more than £50k and half of those cost north of £100k, so you have to dig deep not to lose money (retaining between 65–80% of their list price after three years). This chimes with the earlier example of buying boots; if you can afford a more expensive car, it retains its value better. At the other end of the scale, the bottom ten only retained 30–40% of their value after three years.

Car

Term

Miles

Deposit

Monthly

Total

+Maintenance

Total

Fiat 500

36m

8,000

£2,000

£326/m

£13,510

£364/m

£14,878

Audi A5

36m

8,000

£4,000

£679/m

£27,865

£703/m

£28,729

Audi A5

48m

5,000

£5,000

£571/m

£31,937

£608/m

£33,713

Figure 5: Car finance illustration

Let’s take a 1.0 litre Fiat 500 as a budget example and a nice 2.0 litre Audi A5 Coupe as one you’d probably prefer. Looking at some sample lease deals via Parkers price guide (summarised in Figure 5), the baby Fiat comes in at £326 a month over three years or £13,510 in total costs, or £14,878 in total if you have inclusive maintenance. On the other hand, the Audi looks more of a stretch at £703 a month, so you ask the dealer if they can do you ‘a better deal’ and after a bit of number crunching (and highly likely having left you for a while ‘to go and speak with the manager’) they come back having shaved more than £100 off the deal and we’re now looking at a more palatable £571 a month. Great deal, eh? And for the same car – what a bargain! Except you’re now in a four-year deal, only allowed to do 5,000 miles a year, have increased your deposit by £1,000 and don’t have maintenance included. And the (hidden) cost of this better deal? An additional £3,208 in the dealer’s pocket, plus 14p per mile for every mile you do over 20,000 miles.