Get ready for the downturn

Wary of the stock market and wondering what to do with the money you set aside for Isas? How about using it to cut your mortgage?

Increasing your monthly payments by £50 will save just over £18,500 over the 25-year life of a £70,000 loan and chop five years off the term, says Virgin One.

Or a lump sum payment of £5,000 in the second year of the loan would save you just under £18,000 and cut the term by nearly four years.

Reducing a loan is heartily recommended by mortgage advisers. 'If you put that money into a deposit account instead, it would have to be getting a pretty good rate to beat reducing the mortgage,' says David Hollingworth of London & Country Mortgages.

A higher-rate taxpayer who chose another investment instead would need a gross return of 11.6 per cent to beat the example given by Virgin. Someone on basic-rate tax would need 8.9 per cent gross. These figures would be predicted for 2001 by only the bravest spirits.

It has to be said, however, that the Virgin figures assume a mortgage rate of 6.95 per cent - more than many of us are paying.

Even if your mortgage rate was just 6 per cent, however, as a higher-rate taxpayer you would need to earn 10 per cent to get a better return than cutting the mortgage. A basic-rate taxpayer would have to earn 7.7 per cent.

Good as the idea sounds, there are complications. If you are on a fixed-rate or discounted mortgage deal, there may be a penalty for paying off some or all the loan early. In these cases, it will rarely be worthwhile, says Hollingworth.

Some lenders do, however, let people on these deals pay off something extra each year without incurring the penalty. At many lenders the figure is 10 per cent of the loan.

If you decide to pay off part of your loan, be careful. Many lenders' bureaucratic systems have traditionally been very poor at accepting early repayments.

Hollingworth says: 'Lenders would rather you didn't pay off early. The more you owe, the better it is for them because they are charging you interest.'

So find out from your lender what its system is for partial repayments. Write a note to go with your cheque, explaining it is an early repayment. Keep a copy of the note and check afterwards that the sum has been processed as you wanted.

It could be that your lender will need someone at head office to make a manual adjustment to your account - surprising, but true.

Some lenders set a minimum amount which they will accept as a partial repayment, usually about £250 or £500. So if you are diverting a £50-a-month Isa contribution to your mortgage, you may need to save up the right amount first.

Consumer demand is encouraging lenders to make things easier, however. Among those playing a part are the Nationwide building society, which will take a little as £1 as an early repayment, and Virgin One which offers a 'flexible' mortgage where customers can decide how much to repay each month.

Virgin's 60,000 clients can take payment holidays or overpay. But 92 per cent of them choose to pay more than they need, 2 per cent are on target to pay off their loans in exactly 25 years and just 6 per cent are underpaying.

Research from the Council of Mortgage Lenders concludes that 16 per cent of borrowers are on 'flexible' loans where they can over- and underpay.

London & Country's Hollingworth says most homeowners are risk-averse: 'They see the mortgage as a millstone and they want to get rid of it.'

But payment holidays are useful to people whose circumstances change - if they have a child, for instance.

At a time of stock market uncertainty, paying off some of your loan early can be a sensible. Reducing your liabilities when you have some spare cash can help you sleep better at night - especially if you are worried about losing your job.

Yet if you are laid off, you may want to keep some spare cash to help pay your mortgage before state help kicks in. For homes bought or remortgaged after Octo ber 1995, you have to pay your own homeloan costs for the first nine months of unemployment before the state takes over. For other properties, the state pays half after two months and the full amount after another four

For some people, it will be better not to have Isas and other savings worth more than £8,000. This is the cut-off threshold for many means-tested benefits, including Working Families Tax Credit and the income-based Job Seekers' Allowance, the form of unemployment benefit paid after the first six months of non-means-tested help is over. Welfare workers warn, however, that deliberately offloading savings may disqualify you from pay-outs.

Even when there are no clouds on the economic horizon, there is a strong argument for minimising what you owe. The smaller your debts, the more insulated you are from stock market volatility and other unpredictable events