Overpayment Question

Bullygig

Hi,

I have a quick question that I think I know the answer to but would appreciate it if anyone can confirm.

Imagine you had 2 mortgages, one for £60k with 19 years left and one for £6k with 6 years left, both at the same interest rate.
You could afford to overpay say £100 per month (without penalty), what would be the best course of action?

I am assuming that it would be to overpay on the £60k as every £100 saved means you will be saving interest on that £100 for the next 19 years rather than just 6, am I right?

Also, imagine you had a £6k lump sum. Would it still work in this way, would you be better to pay it off the £60k or just clear the £6k mortgage (again assuming no penalties)?

Any comments gratefully received

silvercar

If they were both calculated on daily interest it shouldn't make any difference.

If you knock money of the capital amount owing the payment schedule should be recalculated on the lower capital amount outstanding.

If I had 6k I would get rid of the smaller mortgage; just to make remortgaging easier and decrease paperwork.

Bullygig

Hi Silver,

Thanks for the reply, however I disagree, but I may be wrong, hence why I'm asking!

If you imagine you had a £60k debt over 19 years and a £6k debt over 6 years, surely no matter how the interest is calculated, if you pay off more of the larger debt, because it is over a longer period you will be saving more in interest than you would be by paying some of the smalller debt off??

silvercar

It all depends how you do it. If you pay 6k off will you then keep your repayments the same or reduce your payments?

At the end of the day your 66k debt is reduced to 60k. Interest on the outstanding money is at the same rate so there should be no difference. Now if you alter your payments this will change the figures. If you cancel the 6k debt but make increased payments on the other one, as much as the 2 payments were before, it should be no different from keeping both debts on provided you keep the payment levels the same.

Where it starts to change things is if you reduce your payments because the debt is smaller.

I would get rid of the smaller one and pay what you were previously paying for both debts onto the larger debt.

Ian_W

I'm no expert and my answer would probably have been the same as silvercar's but using the lump sum, I do see what you mean.

Pay £6k off the £60k and you save more interest because it's over a longer period. At say 5% interest you save £1800 interest on the £6k over 6yrs, whereas you save £5700 paying it off the £60k over 19yrs, saving £3900 interest.

However with the £100 a month overpayment I don't see that it matters. When you've finished the £6k mortgage rather sooner than 6yrs by overpaying, surely you're then going overpay £100pm on the £60k mortgage? The lump sum one only works out cheaper IMO because you're paying interest for a longer period on it and it's a one off payment. If you stop overpaying when the 6K is paid off the same applies but why would you do that?

Might be missing something but I can't figure out what.

BigG_5

Provided you use all your proceeds from overpaying to reduce your debt, it doesn't matter in the long run. Assuming 5.5% interest, the following might explain.

An overpayment on the 19 year loan means not having to pay interest over that amount for 19 years. In the case of £100, this will save you 100*(1.055^19)= £276

An overpayment on the 9 year loan means not having to pay interest over that amount for 9 years. In the case of £100, this will save you 100*(1.055^9)= £162

However, in the second case you could use this saving after the nine years to make an overpayment on the other loan. This will give you 162 * (1.055^10) = £276

It doesn't make a difference, provided you use what you save on the short loan as an overpayment for the longer loan. This is also true is you have 6k to make an overpayment. I'd go with silvercar's suggestion to get rid of the smaller one and pay what you were previously paying for both debts onto the larger debt.