Repaying your debt early almost always pays off in the end

A year or so before the global financial crisis I was lucky enough to come into a little money and the first thing I did was to pay off my mortgage in Dubai. People were borrowing like crazy then and the woman behind the counter at Amlak Finance looked at me as though I had completely lost it.

“No, we can lend you more money, why not take it,” she reasoned. “Charges will apply if you repay early.” Well, fortunately I had a copy of my mortgage agreement handy with the phrase “no early redemption penalties” highlighted in bold, so Amlak accepted my cheque.

It was very nice not to have to pay a monthly mortgage payment when the global financial crisis axed my freelance work and cash flow became tight. That’s the problem with fixed commitments. Your income may not be nearly as reliable.

You should also stop and do the maths. One calculation suggested that an average home would cost its owners three times the initial purchase price when 25 years’ worth of interest was added. Now admittedly very few people ever have the cash available to buy a house outright.

I would never have got on the housing ladder in the early days of Dubai property without a loan from Amlak, for example. At the time the chief executive commented to me that, as my deposit was only 20 per cent, he was taking most of the risk. Buying a property with debt in a rapidly rising housing market is one of the best investments anybody can make.

That said over the years I have met many unfortunate folk who got property wrong, lost their savings and missed out entirely on home equity. Buying at the top of the housing cycle with a lot of debt and then losing a job was the most common problem. Others simply bought a bigger house than they could afford and interest rates unexpectedly went up, as they do, and then they had to sell at the wrong time.

Repaying debts early, if you can afford it, puts you in a safe place. You have a barrier of safety against falling earnings, and you also will not have to sell up should prices fall. If you do not sell an investment that has fallen in value then you do not realise a loss. Yes, my villa fell 60 per cent in value in 2009 and a kindly neighbour did offer to take it off my hands, but I kept it, and the price has since recovered.

Some argue that you should always keep mortgage debt, which is relatively cheap and invest your spare cash elsewhere for higher gains. Great in theory, but would you actually do it? Lifestyles have a habit of always expanding to meet any budget. Besides achieving positive investment results in a world of ultra-low interest rates has not been so easy, and cash in the bank pays an awful lot less than a mortgage actually costs.

My Amlak mortgage cost me 8 per cent. By paying that off, my cash was effectively earning 8 per cent. No bank has paid that sort of risk-free return for five or six years. Once we have established the logic of paying off an innocuous monthly mortgage then it is fairly easy to deal with all other debts that generally cost a lot more.

Indeed an obvious rule of thumb is to start by paying off your debts with the highest interest rates. Why anybody would borrow on a credit card is beyond me. I’ve not missed a payment in 25 years.

This sort of expensive credit, like most unsecured consumer credit is only for the seriously desperate, though the vast majority of these purchases are for non-essential goods. Just do without unless you really can’t.

What many young consumers fail to realise is that in the longer term debt actually keeps you poorer.

That’s because the cost of servicing the debt has to come out of your income, and without those interest payments you will have more and not less to spend. Repaying debts as soon as possible almost always makes sense.

Peter Cooper is the editor of arabianmoney.net

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