Overpayments - do they count more at the start of the term

1399steve

Hi all,

I'm one year into my mortgage, and just started to make the maximum overpayment allowed on my fixed rate deal which runs out in two years.

Is it better to overpay as much as possible towards the start of the mortgage term? i.e. would an overpayment made now take more time off the remaining term than an overpayment of the same value in 5 years time? Or does it not make any difference?

DJ_Mike

Yes, yes, YES

You want to overpay as much as you can (although be careful to keep some cash aside for emergencies) - the earlier you overpay towards your mortgage, the more interest it'll save you in the long run.

I did an illustration in my MFW diary a couple of weeks back, but I'll repeat it here:

If you DIDN'T overpay £100 at the start of a 30-year mortgage, and you had a 5% interest rate that didn't change (unlikely, I know), for all 30 years, that £100 would cost you £5 in interest every year - after 30 years that's £150!

In fact the reality is even worse than that - by forcing you to pay £5 for every £100 each year, the bank is taking money away from you that you'd otherwise be able to spend on paying off the debt! This is essentially the inverse of compound interest! Think of it as the bank depriving you of £5 you could otherwise invest in a savings account which could compound over the next 30 years. The reality, therefore, is that with compounded interest, the real cost to you is £332!

However, if you thought about overpaying that same £100 in the last year of your mortgage, you've already footed the bill for most of the interest that £100 has cost you by being sat there in your mortgage - so the net benefit is that you'd only save 1 year's worth of interest rather than 30 - following the same 5% example this would be just £5! And since there's no real compounding loss here (it is, after all, only a year), it still works out at roughly £5 whatever you do.

So there you have it - the earlier you repay, the more you'll save in years to come!

Do it now!

Edit: To anyone reading this who has a very LOW mortgage rate - do consider that you might actually be better off putting your money in savings. Make sure you take away the amount of tax you'll pay on a savings account tho (unless it's an ISA) - 20% for basic tax payers, 40% for upper earnings tax payers. So if you found a 5% savings account, it'd actually be giving you 4% or 3% in reality, depending on your tax rate.

So if your mortgage is >4% interest rate you're very likely to be better off (right now) by overpaying it!

ailuro2

Ahhh. but......


if you could find a bank account that would pay you 10% interest on your hundred pounds and you left it there instead of paying it off the mortgage in year 1 and it costing you 5% then you'd earn more interest than you would have paid on the mortgage, therefore you would be better off.

That being said, mostly mortgages are higher interest rates than you can earn in the bank, so it makes sense to pay it off.

If you can put it into an overpayment fund rather than pay it off forever it keeps your options open while still benefitting you to the same extent.:D

see my sig for this - we took out our overpayment and are earning more than 5% on it, but only paying 0.99% on the balance of our mortgage.

So it's not so clear cut.

Sounds like you're on the right tracks though.;)

DJ_Mike

Yes this much is true - if you can find a savings account that pays higher than your mortgage rate after tax then you are better off putting your money into that.

I do have a tendency to ignore this as, especially for those people just getting new houses/mortgages for the first time, there isn't a single savings account out there that would beat overpaying the mortgage!

1399steve

Great, so given that i have £6k of 'emergency' savings and am already making the maximum monthly overpayment allowed, my best course of action would be to save as much as possible at the highest rate and then make a lump sum payment as soon as my fixed rate ends?

DJ_Mike

Yes that seems like the best option.

Although does your mortgage provider allow you to increase your regular monthly payments (i.e. reduce the term of your mortgage)? Usually when a provider does this, they still allow you to make overpayments on top - thus you pay off your mortgage even more quickly!

The only caution I'd give is that you are effectively tying yourself into a higher monthly payment which you won't have any control over later - so only do this if you're sure you'll be able to afford it! But definitely worth considering!

ailuro2

http://www.moneysavingexpert.com/mortgages/mortgages-vs-savings

have a read thorhg this - there's a calculator halfway down the page that lets you compare the interest on your mortgage and the interest in your savings account and work out which is the best home for your money.

you will soon see it comes down to the interest rate in your fixed deal.

Read the terms on your mortgage carefully, or phone up the provider, find out how much you can overpay now, and after the fixed deal ends.;)

dimbo61

Hi steve,
As you have £6k in savings you could use whatsthecost website to work out how much extra each month it would cost you to reduce the term by say 1/2/3/4/5 years and if this increased your payment by say £250 a month well you all ready have that money sitting in the bank.
This is only for the next 2 years left on your current deal!
Check with your lender if they make a charge to reduce your term!
GOOD LUCK

StuartGMC

Steve
It sounds like you have a good income : outgoings ratio so you may want to start looking at offset mortgages for the time you change mortgage. You can still overpay, but all the cash offsets so you only pay interest on the difference (you can get accounts which offset current a/c and savings, and some will also offset Cash ISAs - latter can then help while you have a mortgage then revert to earning interest afterwards whilst still in their tax-free wrapper).

The other good thing about offsets is their flexibility and usually no ERC etc.

Best wishes with the journey ahead.

1399steve

thanks all for your comments. You've certainly given me plenty to think about. Going to look into off-set mortgages for when my current deal expires!